** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**

**(MarkOne)**
| **x**                                                                                                                       | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                                                                                        |       |                                                                                                    |
| **For the  quarterly period ended March 31, 2006**                                                                     |
|                                                                                                                        |       |                                                                                                    |
| **or**                                                                                                                      |
|                                                                                                                        |       |                                                                                                    |
| **o**                                                                                                                       | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                        |       |                                                                                                    |
| **For the  transition period from                to** |

 

**Commission File Number 000-50405**

** **

**ACUSPHERE, INC.**

(Exact name of registrant as specified in its charter)
| **Delaware**                                                     | ** ** | **04-3208947**                     |
|------------------------------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of incorporation  or organization) |       | (IRS Employer  Identification No.) |
|                                                             |       |                               |
| **500  Arsenal Street**                                          | ** ** | ** **                         |
| **Watertown,  Massachusetts**                                    | ** ** | **02472**                          |
| (Address of  principal executive offices)                        |       | (Zip Code)                         |

 

Registrant’s Telephone Number, Including Area Code: **(617) 648-8800**

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x  No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler o            Acceleratedfiler o            Non-acceleratedfiler x

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b 2 of theExchange Act). Yes o  No x

As of May 9, 2006 there were 28,781,857 shares of the registrant’scommon stock, $.01 par value per share, outstanding.

 

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**ACUSPHERE, INC.**

**Form 10-QFor the Quarterly Period Ended March 31, 2006**

**CONTENTS**
|                                                                                                     | ** ** | **Page  Number** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------|------------|
| PART I:  FINANCIAL INFORMATION                                                                 |       |             |       |
| Item  1. Financial Statements                                                                       |       |             |       |
| Condensed  Consolidated Balance Sheets: March 31, 2006 and December 31, 2005              |       |             |       |
| Condensed  Consolidated Statements of Operations: Three Months ended March 31, 2006  and 2005  |       |             |       |
| Condensed  Consolidated Statements of Cash Flows: Three Months ended March 31, 2006  and 2005  |       |             |       |
| Notes  to Condensed Consolidated Financial Statements                                               |       |             |       |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       |             |       |
| Item 3. Quantitative and Qualitative Disclosure about  Market Risk                                  |       |             |       |
| Item  4. Controls and Procedures                                                                    |       |             |       |
| PART II:  OTHER INFORMATION                                                                    |       |             |       |
| Item  1. Legal Proceedings                                                                          |       |             |       |
| Item  1A. Risk Factors                                                                              |       |             |       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                |       |             |       |
| Item 3. Defaults Upon Senior Securities                                                             |       |             |       |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        |       |             |       |
| Item  5. Other Information                                                                          |       |             |       |
| Item 6.  Exhibits                                                                                   |       |             |       |
| Signature                                                                                           |       |             |       |

 

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**PART I: FINANCIALINFORMATION**

**ITEM 1.CONSOLIDATED FINANCIAL STATEMENTS**

**ACUSPHERE, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS(unaudited, in thousands except share data)**
| ** **                                                                                                                                                                                                                                                                                              | ** ** | **As of**                | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                              | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                                         |       |                     |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                                               |       | $                        | 37,847     |   | $ | 51,112 |   |
| Accounts receivable                                                                                                                                                                                                                                                                                     |       | 410                      |       | —- |   |
| Other current assets                                                                                                                                                                                                                                                                                    |       | 1,007                    |       | 1,142 |   |
| Total current assets                                                                                                                                                                                                                                                                                    |       | 39,264                   |       | 52,254 |   |
|                                                                                                                                                                                                                                                                                                    |       |                     |       |   |   |
| PROPERTY AND EQUIPMENT,  at cost:                                                                                                                                                                                                                                                                       |       |                     |       |   |   |
| Property and equipment                                                                                                                                                                                                                                                                                  |       | 54,384                   |       | 53,726 |   |
| Less accumulated depreciation and amortization                                                                                                                                                                                                                                                          |       | 14,474                   |       | 11,886 |   |
| Property and equipment, net                                                                                                                                                                                                                                                                             |       | 39,910                   |       | 41,840 |   |
|                                                                                                                                                                                                                                                                                                    |       |                     |       |   |   |
| OTHER ASSETS                                                                                                                                                                                                                                                                                            |       | 1,729                    |       | 1,745 |   |
| TOTAL ASSETS                                                                                                                                                                                                                                                                                            |       | $                        | 80,903     |   | $ | 95,839 |   |
|                                                                                                                                                                                                                                                                                                    |       |                     |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                          | ** ** | ** **               | ** ** | ** ** | ** ** |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                                    |       |                     |       |   |   |
| Current portion of long-term obligations                                                                                                                                                                                                                                                                |       | $                        | 7,193      |   | $ | 6,727 |   |
| Current portion of deferred revenue                                                                                                                                                                                                                                                                     |       | 3,569                    |       | 3,429 |   |
| Derivative liability                                                                                                                                                                                                                                                                                    |       | 1,957                    |       | 1,078 |   |
| Accounts payable                                                                                                                                                                                                                                                                                        |       | 1,308                    |       | 3,180 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                        |       | 5,949                    |       | 6,829 |   |
| Total current liabilities                                                                                                                                                                                                                                                                               |       | 19,976                   |       | 21,243 |   |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                                                                                  |       |                     |       |   |   |
| Long-term obligations, net of current portion                                                                                                                                                                                                                                                           |       | 14,682                   |       | 14,601 |   |
| Deferred revenue, net of current portion                                                                                                                                                                                                                                                                |       | 2,092                    |       | 2,578 |   |
| Total long-term liabilities                                                                                                                                                                                                                                                                             |       | 16,774                   |       | 17,179 |   |
|                                                                                                                                                                                                                                                                                                    |       |                     |       |   |   |
| COMMITMENTS                                                                                                                                                                                                                                                                                             |       |                     |       |   |   |
|                                                                                                                                                                                                                                                                                                    |       |                     |       |   |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                                              |       |                     |       |   |   |
| Preferred stock, $0.01 par value per share                                                                                                                                                                                                                                                              |       |                     |       |   |   |
| Authorized—5,000,000 shares as of March 31,  2006 and December 31, 2005; Designated 6.5% convertible exchangeable -  1,000,000 shares as of March 31, 2006 and December 31, 2005; issued  and outstanding 740,000 shares as of March 31, 2006 and  December 31, 2005 |       | 7                        |       | 7 |   |
| Common stock,  $0.01 par value per share                                                                                                                                                                                                                                                                |       |                     |       |   |   |
| Authorized—98,500,000  shares as of March 31, 2006 and December 31, 2005; issued and  outstanding, 22,910,053 shares as of March 31, 2006 and 22,870,559 as of  December 31, 2005                                                                                              |       | 229                      |       | 229 |   |
| Additional paid-in capital                                                                                                                                                                                                                                                                              |       | 277,669                  |       | 277,592 |   |
| Deferred stock-based compensation                                                                                                                                                                                                                                                                       |       | (247                     | )          | (359 | ) |
| Accumulated deficit                                                                                                                                                                                                                                                                                     |       | (233,505                 | )          | (220,052 | ) |
| Total stockholders’ equity                                                                                                                                                                                                                                                                         |       | 44,153                   |       | 57,417 |   |
| TOTAL                                                                                                                                                                                                                                                                                                   |       | $                        | 80,903     |   | $ | 95,839 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

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**ACUSPHERE,INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS(unaudited, in thousands except share and per share data)**
| ** **                                           | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **March 31,**               | ** ** | **March 31,** | ** ** |
| ** **                                           | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                 |       |                             |       |   |   |
| COLLABORATION  REVENUE                               |       | $                                | 857        |   | $ | 857 |   |
|                                                 |       |                             |       |   |   |
| OPERATING EXPENSES:                                  |       |                             |       |   |   |
| Research and development                             |       | 10,873                           |       | 7,678 |   |
| General and administrative                           |       | 2,554                            |       | 1,747 |   |
| Total operating expenses                             |       | 13,427                           |       | 9,425 |   |
|                                                 |       |                             |       |   |   |
| Interest income                                      |       | 476                              |       | 302 |   |
| Other income  (expense)                              |       | —                           |       | — |   |
| Interest expense                                     |       | (480                             | )          | (141 | ) |
| Change in  valuation of derivative                   |       | (879                             | )          | 434 |   |
| NET LOSS                                             |       | ($13,453                         | )          | ($7,973 | ) |
|                                                 |       |                             |       |   |   |
| Dividends on  preferred stock                        |       | (601                             | )          | — |   |
|                                                 |       |                             |       |   |   |
| NET LOSS  AVAILABLE TO COMMON STOCKHOLDERS           |       | (14,054                          | )          | (7,973 | ) |
|                                                 |       |                             |       |   |   |
| NET LOSS AVAILABLE TO  COMMON STOCKHOLDERS PER SHARE |       |                             |       |   |   |
| Basic and  diluted                                   |       | ($0.61                           | )          | ($0.45 | ) |
|                                                 |       |                             |       |   |   |
| WEIGHTED-AVERAGE SHARES  OUTSTANDING                 |       |                             |       |   |   |
| Basic and diluted                                    |       | 22,887,971                       |       | 17,812,912 |   |
|                                                      |            |                                  |            |  |  |  |  |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

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**ACUSPHERE, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS****(unaudited, in thousands)**
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**               | ** ** | **March 31,** | ** ** |
| ** **                                                                   | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | ** **                       | ** ** | ** ** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                       |       |                             |       |   |   |
| Net loss                                                                     |       | ($13,453                         | )          | ($7,973 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                             |       |   |   |
| Stock-based  compensation expense                                            |       | 683                              |       | 169 |   |
| Depreciation and  amortization                                               |       | 2,588                            |       | 528 |   |
| Noncash interest  expense                                                    |       | 290                              |       | 13 |   |
| Noncash rent  expense                                                        |       | 26                               |       | 128 |   |
| Noncash  amortization of deferred revenue                                    |       | (857                             | )          | (857 | ) |
| Noncash  amortization of fee and warrants to financial advisor               |       | 67                               |       | 67 |   |
| Noncash change  in valuation of derivative                                   |       | 879                              |       | (434 | ) |
| Changes in operating  assets and liabilities:                                |       |                             |       |   |   |
| Deferred revenue                                                             |       | 510                              |       | 1,000 |   |
| Other current  assets                                                        |       | (367                             | )          | (711 | ) |
| Accounts payable                                                             |       | (2,214                           | )          | (1,710 | ) |
| Accrued expenses                                                             |       | (1,040                           | )          | 270 |   |
| Net cash used in  operating activities                                       |       | (12,888                          | )          | (9,510 | ) |
|                                                                         |       |                             |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                       |       |                             |       |   |   |
| Purchases of  property and equipment                                         |       | (316                             | )          | (6,339 | ) |
| Increase in  other assets                                                    |       | 16                               |       | (65 | ) |
| Net cash used in  investing activities                                       |       | (300                             | )          | (6,404 | ) |
|                                                                         |       |                             |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                       |       |                             |       |   |   |
| Payments on  long-term obligations                                           |       | (991                             | )          | (454 | ) |
| Proceeds from  long-term obligations                                         |       | 1,407                            |       | 9,038 |   |
| Net proceeds  from sale of redeemable convertible preferred stock            |       | —                           |       | 41,891 |   |
| Payment of preferred  stock dividends                                        |       | (601                             | )          | — |   |
| Proceeds from  exercise of stock options                                     |       | 80                               |       | 14 |   |
| Proceeds from  issuance of common stock from employee stock purchase plan    |       | 28                               |       | 12 |   |
| Net cash (used  in)/provided by financing activities                         |       | (77                              | )          | 50,501 |   |
|                                                                         |       |                             |       |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                        |       | (13,265                          | )          | 34,587 |   |
|                                                                         |       |                             |       |   |   |
| CASH AND CASH  EQUIVALENTS, Beginning of period                              |       | 51,112                           |       | 45,180 |   |
| CASH AND CASH  EQUIVALENTS, End of period                                    |       | $                                | 37,847     |   | $ | 79,767 |   |
|                                                                              |            |                                  |            |  |  |  |  |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

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**ACUSPHERE, INC. AND SUBSIDIARIES**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS(unaudited)**

**1.****  Basis of Presentation**

The accompanyingunaudited condensed consolidated financial statements of Acusphere, Inc.and Subsidiaries (the “Company”) have been prepared in accordance withgenerally accepted accounting principles in the United States of America forinterim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples in the United States of America for complete financial statements.These statements should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s latest audited annualfinancial statements. Those audited statements are included in our AnnualReport on Form 10-K for the year ended December 31, 2005, whichhas been filed with the SEC.

In the opinion ofmanagement, all adjustments, consisting only of normal, recurring adjustmentsconsidered necessary for a fair presentation of the results of these interimperiods have been included. The results of operations for the three monthsended March 31, 2006 may not be indicative of the results that may beexpected for the full fiscal year.

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period.

**2.****   RevenueRecognition**

The Company recognizesrevenue from license arrangements in accordance with Staff Accounting Bulletin No. 104,Revenue Recognition (SAB 104) and Financial Accounting Standards Board (FASB)Emerging Issue Task Force Issue No. 00-21, “Accounting for RevenueArrangements with Multiple Deliverables” (EITF 00-21). The Companyrecognizes revenue from license payments not tied to achieving a specificperformance milestone ratably over the period over which the Company isobligated to perform services. The period over which the Company is obligatedto perform services is estimated based on available facts and circumstances.The Company recognizes revenue from performance payments, when such performanceis substantially in the Company’s control and when the Company believes thatcompletion of such performance is reasonably probable, ratably over the periodover which the Company estimates that it will perform such performanceobligations. Substantive at-risk milestone payments, which are based onachieving a specific performance milestone when performance of such milestoneis contingent on performance by others or for which achievement cannot bereasonably estimated or assured, are recognized as revenue when the milestoneis achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone.

Revenue in connectionwith license arrangements is recognized over the term of the arrangement and islimited to payments collected or due and reasonably assured of collection. In circumstanceswhere the arrangement includes a refund provision, the Company defers revenuerecognition until the refund condition is no longer applicable unless, in theCompany’s judgment, the refund circumstances are within its operating controland unlikely to occur. Payments received in advance of being recognized asrevenue are deferred. Contract amounts which are not due until the customeraccepts or verifies the research results are not recognized as revenue untilpayment is received or the customer’s acceptance or verification of the resultsis evidenced, whichever occurs earlier.

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**3.   Stock-BasedCompensation**

*Summaryof Stock-Based Compensation Plans*

Under the Company’s 2005Stock Option and Incentive Plan (the “2005 Plan”), the Company may grant up to1,700,000 shares of common stock to be issued as incentive stock options(“ISOs”), nonqualified stock option, awards of common stock and directpurchases of common stock by Acusphere employees, officers, directors andconsultants. The maximum number of shares that may be granted to any employeeunder the 2005 Plan may not exceed 1,000,000 shares of common stock during anycalendar year. Options granted have a term of 10 years and generally vestover four years. The Company settles employee stock option exercises with newlyissued shares. As of March 31, 2006, there were 0.4 million optionsoutstanding under the 2005 Plan. As of March 31, 2006, there were 1.3million shares available for future grant.

Under the Company’s 2003Stock Option and Incentive Plan (the “2003 Plan”), the Company may grant up to2,500,000 shares of common stock to be issued as ISOs, nonqualified stockoption, awards of common stock and direct purchases of common stock byAcusphere employees, officers, directors and consultants. The maximum number ofshares that may be granted to any employee under the 2003 Plan may not exceed583,334 shares of common stock during any calendar year. Options granted have aterm of 10 years and generally vest over four years. The Company settlesemployee stock option exercises with newly issued shares. As of March 31,2006, there were 2.5 million options outstanding under the 2003 Plan. As ofMarch 31, 2006, there were 0.0 million shares available for future grant.

In March 1994, the1994 Stock Plan (the “1994 Plan”) was approved. The 1994 Plan, as amended,provided that a maximum of 1,423,663 shares of common stock could be issued asISOs, nonqualified stock options and stock grants. The Company ceased grantingawards under the 1994 Plan after March 7, 2004. As of March 31, 2006,there were 1.1 million options outstanding under the 1994 Plan.

In July 2003, the2003 Employee Stock Purchase Plan (the “Purchase Plan”) was approved. ThePurchase Plan provides for the issuance of a maximum of 233,334 shares ofcommon stock. Eligible employee may contribute up to 10% of their total cashcompensation with a maximum of 417 shares semi-annually. The Company settlesemployee stock purchases under the Purchase Plan with newly issued shares.Acusphere had 215,721 shares available for future sales of common stockunder this plan at March 31, 2006.

*Change inAccounting for Stock-Based Compensation Plans*

Prior to January 1,2006, the Company had followed Accounting Principles Board (APB) OpinionNo. 25, “Accounting for Stock Issued to Employees” and relatedinterpretations, which resulted in the accounting for grants of awards toemployees at their intrinsic value in the consolidated financial statements.Accordingly, no compensation expense was recorded for options issued toemployees in fixed amounts and with fixed exercise prices at least equal to thefair market value of the Company’s common stock at the date of grant.Conversely, when the exercise price for accounting purposes was below fairvalue of the Company’s common stock at the date of grant, a non-cash charge tocompensation expense was recorded ratably over the term of the option vestingperiod in an amount equal to the difference between the value calculated usingthe exercise price and the fair value. The Company did issue options prior toits initial S-1 filing in July 2003 at values less than fair market.These grants resulted in the recording of deferred compensation.

Effective January 1,2006, the Company adopted FAS No. 123R, “Accounting for Stock-BasedCompensation,” (FAS 123R) using the modified prospective method, which resultsin the provisions of FAS 123R being applied to the consolidated financialstatements on a going-forward basis. Prior periods have not been restated. FAS123R requires companies to recognize stock-based compensation awards granted toits employees as compensation expense on a fair value method. Under the fairvalue recognition provisions of FAS 123R, stock-based compensation cost ismeasured at the grant date based on the fair value of the award and isrecognized as expense over the service period, which generally represents thevesting period. The grant date fair value of stock options is calculated usingthe Black-Scholes option-pricing model and the grant date fair value ofrestricted stock is based on intrinsic value. The expense 

7

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recognized over theservice period is required to include an estimate of the awards that will beforfeited. Previously, the Company recorded the impact of forfeitures as theyoccurred. Options granted prior to the initial S-1 filing in 2003 continue tobe accounted for under APB No. 25.

All stock-based awards tonon-employees are accounted for at their fair market value in accordance withFAS 123R and Emerging Issues Task Force No. 96-18, “Accounting forEquity Instruments Than Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services.”

Stock-based compensationexpense was $0.7 million for the three months ending March 31, 2006.The incremental effect on stock compensation expense as a result of theadoption of FAS 123R was a charge of approximately $0.6 million, or $0.03 pershare. The Company recognized the full impact of its stock based compensationincentive plans in the consolidated statement of operations for the threemonths ended March 31, 2006 under FAS 123R. The following table presentsstock-based compensation expense included in the Company’s consolidatedstatement of operations (in millions):

|                                    | ** ** | **Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|
| ** **                         | ** ** | **March 31, 2006**     | ** ** |
| Research &  Development   |       | $                                | 0.3        |   |
| General &  administrative |       | 0.4                              |       |
| Total                              |       | $                                | 0.7        |   |

 

The Company hadpreviously followed the disclosure-only provisions of FAS No. 123,“Accounting for Stock-Based Compensation,” as amended by FAS No. 148,“Accounting for Stock-Based Compensation — Transition and Disclosure.” Thefollowing table illustrates the effect on net loss and loss per share for thethree months ended March 31, 2005 as if the Company had applied the fairvalue recognition provisions of FAS 123 to stock-based employee awards.

|                                                                                       | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                            | ** ** | **March 31, 2005**     | ** ** |
| ** **                                                                            | ** ** | **Proforma**                     | ** ** |
| **(in thousands, except per share amounts)**                 | ** ** | ** **                       | ** ** |
| Net loss applicable to  common stockholders, as reported:                             |       | $                                | 7,973      |   |
| Add: Stock based employee compensation expense  included in reported net loss    |       | 137                              |       |
| Deduct: Stock based employee compensation expense  determined under fair value method |       | (529                             | )          |
| Net loss                                                                              |       | $                                | 8,365      |   |
| Net loss per  common share (basic and diluted), as reported                           |       | $                                | (0.45      | ) |
| Net loss per common  share (basic and diluted)                                        |       | $                                | (0.47      | ) |

 

As described above, theCompany had previously recorded deferred compensation for below fair valueoptions granted prior to the initial S-1 filing in 2003. As ofMarch 31, 2006, $0.2 million of deferred compensation has yet to berecognized. Such amounts will be recognized over the next twelve months. TheCompany continues to expense this deferred stock-based compensation tooperations over the vesting period of the options, resulting in $0.1 millionand $0.1 million as stock-based compensation expense for the three months endedMarch 31, 2006 and March 31, 2005, respectively.

The Company uses theBlack-Scholes option-pricing model to estimate the fair value of the options atthe grant date. The fair values of options granted during the three-month periodended March 31, 2006 were calculated using the following weighted-averageassumptions:

8

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|                         | ** ** | **Stock Options** | ** ** | **ESPP** | ** ** |
|-------------------------|------------|------------------------|------------|----------|------------|
| Volatility              |       | 36.6                   | %          | 37.0     | %          |
| Risk-free interest rate |       | 4.6                    | %          | 4.83     | %          |
| Expected Dividend Yield |       | 0                      | %          | 0        | %          |
| Expected option  life   |       | 5 years                |       | 6 months |       |

 

The Company used thehistorical volatility of the Company’s market-traded stock to determine theexpected volatility assumption. This volatility assumption is consistent withthe Company’s volatility assumptions made in accordance with FAS 123 forpurposes of the above pro forma information. The risk-free rate is based on theU.S. Treasury yield curve in effect at the time of stock option grants and isbased upon observed interest rates appropriate for the terms of such grants.

The expected life ofemployee stock options represents the weighted-average period the stock optionsare estimated to remain outstanding. The expected life of employee stockoptions is a function of the options’ remaining contractual life and the extentto which the option is in-the-money (i.e., the average stock price during theperiod is above the strike price of the stock option). The Company estimatesthat, based on these variables, options are likely on average to be exercisedin 5 years. The option life for options under the ESPP is six months,representing the time period under which the option may be exercised as definedin the plan.

As share-basedcompensation expense recognized in the condensed consolidated statement ofoperations for the three months ended March 31, 2006 is based on awardsultimately expected to vest, it should be reduced for estimated forfeitures.FAS 123R requires forfeitures to be estimated at the time of grant and revised,if necessary, in subsequent periods if actual forfeitures differ from thoseestimates. Forfeitures were initially estimated at 2.5% annual rate, butadjusted to actual in the three months ended March 31, 2006 due to themonthly vesting of option grants.

*StockOptions*

During the three monthsended March 31, 2006, the Company granted stock options to existingemployees, as part of the Company’s performance review process, to newemployees and to Directors in lieu of cash-based compensation. All such optionswere granted with exercise prices equal to the current market value of theunderlying common stock on the date of grant. Aggregate stock options grantedduring 2006 are as follows:

|                                                  | ** ** | ** **         | ** ** | ** **              | ** **       | **Weighted Average** | ** ** |
|--------------------------------------------------|------------|--------------------|------------|-------------------------|------------------|---------------------------|------------|
| ** **                                       | ** ** | **Number of** | ** ** | **Exercise Price** | ** **       | **Exercise Price**   | ** ** |
| ** **                                       | ** ** | **Shares**         | ** ** | **Per Share**      | ** **       | **Per Share**        | ** ** |
| For the three months  ended March 31, 2006: |       | 928,829            |       | $                       | 5.42 – $6.5 | 9                         | $          | 5.84 |   |
|                                                  |            |                    |            |                         |                  |                           |            |  |  |

 

In addition, the companyissued 5,636 shares of its common stock under the ESPP during the 3 monthsended March 31, 2006 at $4.96 per share, reflecting 85% of the value ofthe closing stock price on February 28, 2006.

The following tablesummarizes the stock option activity in the stock-based compensation plans fromJanuary 1, 2006 through March 31, 2006:
| ** **                        | ** ** | ** **         | ** ** | ** **                                                     | ** ** | **Weighted** | ** ** |
|-----------------------------------|------------|--------------------|------------|----------------------------------------------------------------|------------|--------------|------------|
| ** **                        | ** ** | ** **         | ** ** | ** **                                                     | ** ** | **Average**  | ** ** |
| ** **                        | ** ** | **Number of** | ** ** | **Exercise Price**                                        | ** ** | **Exercise** | ** ** |
| ** **                        | ** ** | **Shares**         | ** ** | **Per Share**                                             | ** ** | **Price**    | ** ** |
| Balance,  January 1, 2006    |       | 3,135,033          |       | $0.84 – $13.02                                            |       | $            | 6.23       |   |
| Granted                           |       | 928,829            |       |   5.42 –     6.59 |       | 5.84         |       |
| Exercised                         |       | (30,648            | )          |   0.84 –     5.57 |       | 2.62         |       |
| Canceled                          |       | (113,330           | )          |   0.84 –     8.50 |       | 5.90         |       |
| Balance,  March 31, 2006     |       | 3,919,884          |       | $0.84 – $13.02                                            |       | $            | 6.18       |   |
|                              |       |               |       |                                                           |       |         |       |
| Exercisable,  March 31, 2006 |       | 1,602,212          |       | $0.84 – $13.02                                            |       | $            | 6.02       |   |

 

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The followingtable summarizes information related to the Company’s options at March 31,2006:
| ** **              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **              | ** ** | ** **                   | ** ** | **Outstanding  Weighted-**   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **                   | ** ** | **Average**                  | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **              | ** ** | ** **                   | ** ** | **Remaining**                | ** ** | **Average** | ** ** | **Exercisable** | ** ** | **Average** | ** ** |
| ** **              | ** ** | **Number of**           | ** ** | **Contractual**              | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise Price** | ** ** | **Shares**                   | ** ** | **Life (in Yrs)**  | ** ** | **Price** | ** ** | **of Shares** | ** ** | **Price** | ** ** |
| $0.00 - 1.31            |       | 447,651                      |       | 6.2                          |       | $ | 0.87 |   | 383,596 |   | $ | 0.87 |   |
| 1.31 - 3.91             |       | 61,658                       |       | 2.7                          |       | 1.89 |   | 61,658 |   | 1.89 |   |
| 3.91 - 5.21             |       | 294,900                      |       | 9.4                          |       | 4.83 |   | 90,116 |   | 4.85 |   |
| 5.21 - 6.51             |       | 1,996,359                    |       | 9.2                          |       | 5.83 |   | 388,524 |   | 5.89 |   |
| 6.51 - 7.81             |       | 301,993                      |       | 6.8                          |       | 7.03 |   | 210,587 |   | 7.19 |   |
| 7.81 - 9.11             |       | 314,477                      |       | 7.6                          |       | 8.70 |   | 169,084 |   | 8.70 |   |
| 9.11 - 10.42            |       | 218,500                      |       | 7.9                          |       | 9.59 |   | 118,100 |   | 9.59 |   |
| 10.42 - 13.02           |       | 284,346                      |       | 7.4                          |       | 13.02 |   | 180,547 |   | 13.02 |   |
|                    |       | 3,919,884                    |       | 8.3                          |       | $ | 6.18 |   | 1,602,212 |   | $ | 6.02 |   |

 

The total cash received fromemployees as a result of employee stock option exercises during the three-monthperiod ended March 31, 2006 was approximately $0.1 million.

As of March 31,2006, the aggregate intrinsic value of outstanding options is $5.2 million, andthe aggregate intrinsic value of  fullyvested and exercisable options is $3.0 million, representing the totalpre-tax intrinsic value, based on the Company’s closing common stock price of$6.69 as of March 31, 2006, which would have been received by the optionholders had all option holders exercised their options as of that date. Thetotal intrinsic value of options exercised during the three-month period endedMarch 31, 2006 was $0.1 million.

As of March 31,2006, there was $6.0 million of total expected unrecognized compensationcost related to unvested stock options granted under the Company’s stock-basedcompensation plans. That cost is expected to be recognized over aweighted-average period of 2.4 years.

The weighted-averagegrant date fair value for options granted during the three-month period endedMarch 31, 2006 was $2.32. The total fair value of options vested duringthe three-month period ended March 31, 2006 was $0.2 million.

**4.****  Net Loss Per Common Share**

Basic and diluted netloss per common share is calculated by dividing the net loss applicable tocommon stockholders by the weighted-average number of unrestricted commonshares outstanding during the period. Diluted net loss per common share is thesame as basic net loss per common share, since the effects of potentiallydilutive securities are anti-dilutive for all periods presented. Anti-dilutivesecurities, which consist of convertible exchangeable preferred stock, stockoptions, warrants, and restricted common stock, which are not included in thediluted net loss per share calculation, aggregated 10,630,728 and 10,539,401 asof March 31, 2006 and 2005, respectively.

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The following tablereconciles weighted-average common shares outstanding to the shares used in thecomputation of basic and diluted weighted-average common shares outstanding:
| ** **                                                           | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                           | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
| Weighted-average  common shares outstanding                          |       | 22,888,979                       |       | 17,817,764 |   |
| Less  weighted-average unvested restricted common shares outstanding |       | (1,008                           | )          | (4,852 | ) |
| Basic and diluted  weighted-average common shares outstanding        |       | 22,887,971                       |       | 17,812,912 |   |

 

**5.****   Propertyand Equipment**

Property and equipment atcost consist of the following (in thousands):
| ** **                       | ** ** | **As of**               | ** ** | ** **                      | ** ** |
|----------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** | **Useful Life** | ** ** |
| Equipment                        |       | $                            | 22,790     |                            | $          | 20,589 |   | 3-5 years |   |
| Furniture and  fixtures          |       | 379                          |       | 345                             |       | 5 years |   |
| Leasehold  improvements          |       | 30,986                       |       | 30,986                          |       | (a) |   |
| Sub-total  depreciable assets    |       | $                            | 54,155     |                            | $          | 51,920 |   |   |   |
| Less:  accumulated depreciation  |       | (14,474                      | )          | (11,886                         | )          |   |   |
| Total  depreciable assets, net   |       | 39,681                       |       | 40,034                          |       |   |   |
| Deposits on  equipment purchases |       | 229                          |       | 1,205                           |       | n/a |   |
| Construction in  progress        |       | —                       |       | 601                             |       | n/a |   |
| Total property and  equipment    |       | $                            | 39,910     |                            | $          | 41,840 |   |   |   |

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(a)             Thecompany depreciates leasehold improvements and equipment under captial leasesover the lesser of their useful lives or the remainder of their respectivelease terms.

Leasehold improvementsprimarily represent costs incurred for the build-out of the Company’scommercial manufacturing facility in Tewksbury, Massachusetts, which are beingdepreciated over the remaining lease term. Deposits on equipment purchasesrepresent progress payments made for long-lead time capital equipmentpurchases, the majority of which are associated with development and expansionof the Company’s manufacturing operations for AI-700.

**6.****   Long-termObligations**

The carrying value oflong-term obligations is as follows (in thousands):

|                              | ** ** | **As of**               | ** ** |
|------------------------------|------------|------------------------------|------------|
| ** **                   | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
| Capital lease  obligations   |       | $                            | 85         |   | $ | 65 |   |
| Notes payable                |       | 16,092                       |       | 15,696 |   |
| Other long-term  obligations |       | 5,698                        |       | 5,567 |   |
|                         |       | 21,875                       |       | 21,328 |   |
| Less current  maturities     |       | (7,193                       | )          | (6,727 | ) |
| Long term obligations,  net  |       | $                            | 14,682     |   | $ | 14,601 |   |

 

Long-term obligationsoutstanding as of March 31, 2006, including current maturities, consistedof capital equipment leased under various capital lease arrangements,promissory notes under equipment financing lines, and borrowings under afacility loan agreement. Monthly payments under the capital lease obligationsmature through June 2010.

**7.****   DeferredRevenue**

In July 2004, theCompany entered into a collaboration, license and supply agreement with Nycomedin which the Company granted Nycomed rights to develop and market AI-700in Europe. As part of this agreement, as of March 31, 2006, Nycomed haspaid the Company $11.0 million in license fees, including the first seven ofeight consecutive quarterly installments of $1.0 million each for the Company’sresearch and development efforts. As of March 31, 2006, the Company hascumulatively recognized $6.0 million in revenue, reflecting an estimated periodof forty-two months over which the $12.0 million in scheduled payments areexpected to be 

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earned. $5.0 million ofsuch payments were included in deferred revenue at March 31, 2006.

In October 2005 and February 2006,the Company and Nycomed amended the agreement to accelerate $2.0 million inmilestone payments in order to fund certain activities associated with branddevelopment and qualification of our commercial manufacturing facility.Payments received or invoiced pursuant to these amendments, including $0.5million through March 31, 2006, are considered advances against a futuremilestone payment for a European regulatory filing, or Marketing AuthorizationApplication (“MAA”). These amounts are classified as deferred revenue until theMAA milestone is achieved, provided that the applicable revenue recognitioncriteria are met.

**8.****  Stockholders’ Equity**

On February 24,2005, the Company issued 900,000 shares of 6.5% convertible exchangeable preferredstock (the “Preferred Stock”) at $50.00 per share resulting in aggregate grossproceeds to the Company of $45.0 million (net proceeds of approximately $41.9million after deducting underwriting discounts, commissions and offeringexpenses). Each share of Preferred Stock has a liquidation preference of $50.00per share. As of March 31, 2006, 740,000 shares of Preferred Stock wereoutstanding.

Dividends on thePreferred Stock are cumulative from the date of original issue at the annualrate of $3.25 per share, payable quarterly on the first day of March, June,September, and December. Any dividends must be declared by the Company’s boardof directors and must come from funds that are legally available for dividendpayments. Through the period ended March 31, 2006, total dividendsaccumulated on the Preferred Stock were $3.0 million, of which $2.8 millionwere paid as of March 31, 2006. In May 2006, the Company’s board ofdirectors declared a quarterly dividend in the amount of $0.8125 per share ofPreferred Stock, which is scheduled to be paid on June 1, 2006 to theholders of record as of the close of business on May 15, 2006.

The Preferred Stock isconvertible into the Company’s common stock at any time at the option of theholder at a conversion rate of 7.2886 shares of common stock for each share ofPreferred Stock, based on an initial conversion price of $6.86 per share. Theinitial conversion price is subject to adjustment in certain customary events,but is not subject to “price based” anti-dilution adjustment. The Company hasreserved approximately 6.6 million shares of common stock for issuance uponsuch conversion.

The Company may elect toautomatically convert some or all of the Preferred Stock into shares of commonstock if the closing price of the Company’s common stock has exceeded $10.30per share (150% of the conversion price) for at least 20 trading days duringany 30-day trading period, ending within five trading days prior tonotice of automatic conversion. Prior to March 1, 2009, if the Companyelects to automatically convert, or if any holder elects to voluntarilyconvert, the Preferred Stock, the Company will also make an additional payment(“Make-Whole” payment) equal to the aggregate amount of dividends that wouldhave been payable on the Preferred Stock so converted from the original date ofissuance through and including March 1, 2009, less any dividends alreadypaid on the Preferred Stock. This additional payment is payable by the Company,at its option, in cash, in additional shares of its common stock, or in acombination of cash and shares of common stock. The Company has reserved amaximum of approximately 2.0 million shares of common stock for issuance underthis Make-Whole provision.

In accordance withSFAS 133, the Company is required to separate and account for as an embeddedderivative, the dividend make-whole payment feature of the Preferred Stockoffering. As an embedded derivative instrument, the dividend make-whole paymentfeature must be measured at fair value and reflected as a liability. Changes inthe fair value of the derivative are recognized in earnings as a component ofother income/(expense). The Company determined the fair value of the dividendmake-whole payment feature to be $3.1 million at February 24, 2005 (thecommitment date). This amount was allocated from the proceeds of the PreferredStock to the derivative liability. During 2005, make-whole payments related tothe conversion of 160,000 shares were made and the derivative liability wasreduced for the fair value of these payments. At March 31, 2006 thederivative liability was revalued at $2.0 million, resulting in the recognitionof $0.9 million of other expense for the three months ended March 31,2006.

The Company may elect toredeem the Preferred Stock on or after March 6, 2009 at decliningredemption prices on or after March 6, 2009.

The Preferred Stock isexchangeable, in whole but not in part, at the option of the Company on anydividend payment date beginning on March 1, 2006 (the “Exchange Date”) forthe Company’s 6.5% convertible subordinated debentures (“Debentures”) at therate of $50 principal amount of Debentures for each share of Preferred Stock. TheDebentures, if issued, will mature 25 years after the Exchange Date and haveterms substantially similar to those of the Preferred Stock. The PreferredStock has no maturity date and no voting rights prior to conversion into commonstock, except under limited circumstances.

In April 2006, onestockholder voluntarily converted 10,000 shares of preferred stock into 72,886shares of the Company’s common stock. In connection with the conversion, theCompany issued an additional 15,526 shares of the Company’s common stock insatisfaction of the required Make-Whole payment.

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**9.****  Subsequent Events**

*Sale ofCommon Stock and Warrants*

On April 12, 2006,the Company sold 5,772,004 units, each unit consisting of (i) one share ofcommon stock (ii) one warrant to purchase 0.3 shares of common stock at anexercise price of $7.97 per share, for a purchase price of $6.9675 per unit,resulting in aggregate gross proceeds to the Company of $40.2 million (netproceeds of approximately $37.8 million after deducting underwriting discountsand commissions and estimated offering expenses). Units are not issued orcertificated. The shares of common stock and warrants are immediately separableand will be issued separately.  Thewarrants will be exercisable beginning on October 12, 2006 and until April 12,2011. In connection with the offering, the Company agreed to refrain fromdirectly or indirectly selling or offering to sell any shares of common stockor securities convertible into or exchangeable or exercisable for shares ofcommon stock, or filing a registration statement offering its common stock orsecurities convertible into or exchangeable or exercisable for shares of commonstock, for a period of 60 days following the offering of common stock, subjectto adjustment under certain circumstances.

**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

**ForwardLooking Statements May Prove Inaccurate**

*Statementscontained herein, including without limitation, “Management’s Discussion andAnalysis of Financial Condition and Results of Operation,” contains certainprojections, estimates and other forward-looking statements. “Forward-lookingstatements,” as that term is defined in the Private Securities LitigationReform Act of 1995, are not historical facts and involve a number of risks anduncertainties. Words herein such as “may,” “will,” “should,” “could,” “would,” “expects,”“plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “intends,”“potential,” and similar expressions (as well as other words or expressionsreferencing future events, conditions or circumstances) are intended toidentify forward-looking statements.*

*Forward-lookingstatements include, but are not limited to: our plans to develop and market newproducts and the timing of these development programs, in particular the timingof clinical trials and regulatory milestones for AI-700; our clinicaldevelopment of product candidates, clinical trials and our ability to obtainand maintain regulatory approval for our product candidates; our estimatesregarding our capital requirements and our needs for additional financing; ourestimates of expenses and future revenues and profitability; our estimates ofthe size of the potential markets for our product candidates; our selection andlicensing of product candidates; our ability to attract collaborators with acceptabledevelopment, regulatory and commercialization expertise; the benefits to bederived from corporate collaborations, license agreements and othercollaborative efforts, including those relating to the development andcommercialization of our product candidates; sources of revenues andanticipated revenues, including contributions from corporate collaborations,license agreements and other collaborative efforts for the development andcommercialization of products; our ability to create an effective direct salesand marketing infrastructure for products we elect to market and sell directly;the rate and degree of market acceptance of our product candidates; the timingand amount of reimbursement for our product candidates; the success of othercompeting therapies that may become available; and the manufacturing capacityfor our product candidates, including our plans to qualify a commercialmanufacturing facility for AI-700.*

*Ouractual results and the timing of certain events may differ materially from theresults discussed, projected, anticipated or indicated in any forward-lookingstatements. Any forward-looking statement should be considered in light offactors discussed in Part II, Item 1A “Risk Factors” and elsewhere in thisreport. We caution readers not to place undue reliance on any suchforward-looking statements, which speak only as of the date they are made. Wedisclaim any obligation, except as specifically required by law and the rules ofthe Securities and Exchange Commission, to publicly update or revise any suchstatements to reflect any change in company expectations or in events,conditions or circumstances on which any such statements may be based, or thatmay affect the likelihood that actual results will differ from those set forthin the forward-looking statements.*

*Thefollowing discussion should be read in conjunction with our consolidatedfinancial statements and related notes thereto included elsewhere in this Form 10-Q.*

 

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**Overview**

We are a specialtypharmaceutical company that develops new drugs and improved formulations ofexisting drugs using our proprietary porous microparticle technology. We arefocused on developing proprietary drugs that can offer significant benefitssuch as improved safety and efficacy, increased patient compliance, greaterease of use, expanded indications or reduced cost. Our three initial productcandidates are designed to address large unmet clinical needs withincardiology, oncology and asthma. Our lead product candidate is a cardiovasculardrug in Phase 3 clinical development for the detection of coronary heartdisease, the leading cause of death in the United States.

We created our initialproduct candidates using technology that enables us to control the size andporosity of particles in a versatile manner, so we can customize the particlesto address the delivery needs of a variety of drugs. We are focused on creatingporous microparticles that are smaller than red blood cells. Some of these microparticlesare nanoparticles which are smaller than 1 micron. Small microparticles areimportant for delivering drugs intravenously so that they can pass through thebody’s smallest blood vessels, for increasing the surface area of a drug sothat the drug will dissolve more rapidly, and for delivering drugs to the lungvia inhalation. Porosity is important for entrapping gases in microparticles,for controlling the release rate of the drug from a microparticle, and fortargeting inhaled drugs to specific regions of the lung.

We have incurredsignificant operating losses to develop our product candidates and weanticipate continuing to incur significant operating losses in the comingyears. In particular, we expect to incur significant additional expenses andexperience other significant capital requirements for the conduct of our Phase3 clinical program for AI-700 and to complete the build-out andqualification of a manufacturing facility for the initial commercialmanufacture of AI-700. Since our inception, we have funded our operationsprimarily through private and public placements of equity securities,equipment-backed financings and other debt financings.

**AI-700Phase 3 Clinical Trial**

Our Phase 3 clinical planprovides for a two-part program consisting of a pilot phase (the “pilot study”),under which new investigators and blinded readers have been qualified andtrained, and two independent multi-center pivotal trials. These two pivotaltrials, previously referred to as the “32” and “33” trials, in preparation forcompletion of the trials have been re-named RAMP 1 and RAMP 2, respectively. “RAMP”stands for Real-time Assessment of Myocardial Perfusionwith echocardiography. Clinical investigators were qualified in the pilot phaseon a rolling basis. The pilot phase was completed in 2005. Clinicalinvestigators in the Phase 3 pivotal studies are located at clinical sites inNorth America, Europe and Australia. Data from the Phase 3 pivotal studies areintended for submission to U.S., European, and potentially other regulatoryauthorities.

*ThePivotal Trials.* Aspart of the Phase 3 pivotal study design, the evaluation of AI-700enhanced stress echo and nuclear stress images from the pivotal trials isperformed by blinded readers who receive no information about the patient beingevaluated other than the images. During the pivotal trials, we intentionallyhave no access to efficacy data. We do not expect to publicly disclose resultsfrom either pivotal trial until after each trial is closed, quality control checksare completed, the database is locked, the data are revealed to us and we havehad an opportunity to review and understand the data, including data regardingclinical outcomes and safety results. As of the date of this quarterly report,over 750 patients with known or suspected coronary heart disease have beenenrolled in the Phase 3 pivotal trials, comprised of 321 patients in the RAMP 1trial and over 400 patients in the RAMP 2 trial. We use statistical models topredict the number of patients we need in each trial to be able to reachstatistical significance. The estimates and assumptions that we are using inour statistical models are primarily derived from our prior clinical studies.Based upon these estimates and assumptions and our statistical analysis plan,we believe that the number of patients that we have enrolled in each of thepivotal studies may be sufficient to achieve statistical significance in thesetrials.

*TheRAMP 1 Trial.* All ofthe patients enrolled in this trial receive a stress echo study with AI-700and a nuclear stress test. Patients in this pivotal trial generally undergocoronary angiography only if they have a positive nuclear stress test result.Patients in this pivotal trial who have a negative nuclear stress test result willbe evaluated for ninety days thereafter for cardiac events. The primaryendpoints of the RAMP 1 trial are accuracy, sensitivity and specificityrelative to a truth standard, in comparison to the performance of nuclearstress testing relative to the same truth standard. We have added accuracy asan additional endpoint to this trial, which is defined as a measure of howfaithfully the information obtained using AI-700 reflects the “truth” asindicated by the study truth standard (primarily coronary angiography). Sensitivityand specificity are subsets of accuracy. The truth standard for both modalitiesis determined with angiography, whenever available, or coronary heart diseasestatus with nuclear stress if angiographic data are unavailable. In December 2005,we ceased enrollment of patients in the RAMP 1 trial. In March 2006, weannounced to the clinical sites that we have completed enrollment in this trial.We have now completed the 90-day follow up period on patients enrolled inthis trial. We anticipate making a public announcement regarding the RAMP 1trial results before the end of the second quarter of 2006.

*TheRAMP 2 Trial.* All ofthe patients enrolled in this trial receive a stress echo study with AI-700and undergo coronary angiography. The majority of patients, but not all, willhave a nuclear stress test. All patients in this trial will be evaluated for upto thirty days following the stress echo study. The primary endpoints of theRAMP 2 trial are accuracy, sensitivity and specificity, relative to a truthstandard, in comparison to the performance of nuclear stress testing, withangiography as the truth standard for both modalities. As of the date of thisquarterly report, and in accordance with the flexibility permitted by our studyplan, we are continuing to enroll 

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patients in the RAMP 2 trial and anticipate continuingto enroll patients until the end of the second quarter of 2006. We believe thatwe can continue to enroll patients in the RAMP 2 trial through the secondquarter of 2006 without delaying our NDA filing date as we project thatqualification of our commercial manufacturing facility is the rate-limitingfactor to our NDA filing. Our clinical plan, unless otherwise amended, permitsus to enroll approximately 450 patients in this study. Once enrollment isclosed in this trial and all angiography procedures and the 30-daypatient follow-up period are completed, we will conduct quality control checksto ensure that all of the required information has been fully gathered andfiled and then lock the database. At that time, the data may be unblinded andavailable to Acusphere for analysis. We anticipate that this quality controlperiod should be completed within three months of completing the angiographyprocedures and the post-enrollment follow-up period and that we will haveunblinded data from this trial during the fourth quarter of 2006. We anticipatemaking a public announcement regarding the trial results during the fourthquarter of 2006.

*TrialDesign and Purpose.* Webelieve that stress echo with AI-700 has the potential to significantlyreduce the time, cost and resources needed in the assessment of myocardialperfusion, compared to nuclear stress testing. Myocardial perfusion is bloodflow to the heart muscle, a sensitive marker for coronary heart disease. Thereis no ultrasound contrast agent approved by FDA for use in stress echo ormyocardial perfusion imaging. Based upon the end points described above, ourRAMP 1 and RAMP 2 trials are designed to demonstrate non-inferiority of stressecho with AI-700 relative to nuclear stress testing. In April 2005,based in part upon feedback from FDA, we revised the statistical analysis planon which we base our patient enrollment estimates for the AI-700 Phase 3clinical trials. Since that time we have continued discussions with the FDAregarding trial design and our statistical analysis plan. As a result of ourongoing discussions with FDA, we may make further revisions. These discussionscould lead to delays in the public announcement of the results from our Phase 3clinical trials, change our sample size estimates and affect whether AI-700is approved for the indication that we are seeking, the timing of such approvalor whether AI-700 is approved at all.

The estimates of, patientenrollment requirements and timing of clinical enrollment, blinded reads, datalock, data release and NDA filing in our Phase 3 trials described abovereflect our current assumptions, based on our knowledge and experience and theguidance of our advisors. We cannot assure you that these timelines will bemet, nor can we assure you that our estimates and assumptions will not changebased upon ongoing regulatory feedback or that, when the trials are completed,we will successfully achieve results that meet or exceed the clinical endpointsof these Phase 3 trials.

**AI-700Manufacturing Facility Update**

We intend to demonstratethat we can produce AI-700 at a commercial manufacturing scale prior toour filing of a NDA for AI-700 and, subject to required regulatoryapprovals, we intend to manufacture AI-700 in this facility forcommercial use. This commercial manufacturing facility must comply with currentgood manufacturing practices, or cGMPs, enforced by the FDA and overseasregulatory agencies.

In July 2004, weentered into a lease agreement for 58,000 square feet of commercialmanufacturing and office space in Tewksbury, Massachusetts. In 2005, wesubstantially completed the build-out of this facility and commenced start-upactivities relating to the manufacturing equipment installed at the site. Depreciationof costs incurred for this build-out commenced in the fourth quarter of 2005when the related assets were placed into service. In March 2006, wesubstantially completed the commissioning of the manufacturing facility. In thesecond quarter of 2006 we intend to begin producing development batches of AI-700at the site. In addition, we are working to qualify the facility in compliancewith cGMP’s. Completion of such qualification includes significant testing,documentation and other related costs which are expensed as incurred. It alsorequires that we successfully demonstrate that we can produce AI-700product within specifications which are consistent with the clinical trialmaterial used in our Phase 3 clinical program, including product storagestability studies. We have previously demonstrated that we can produce AI-700in a qualified manner at contract manufacturing sites. We need to repeat thisdemonstration in our commercial manufacturing facility prior to filing our NDA.Based upon our current plans, we expect to complete this qualification phasebefore the end of the second quarter of 2007, after which we will believe thatwe will have all of the manufacturing related data necessary to file our NDA.

Although the build-out ofthe facility and the commissioning of the equipment are substantially complete,we cannot assure you that we will not encounter complications in thequalification of operations in this facility, which complications could addadditional costs or delay our filing of a NDA for AI-700. In support ofour efforts to qualify our commercial manufacturing facility for AI-700,in February 2006, we and Nycomed agreed to amend the 2004 strategiccollaboration agreement resulting in commitment by Nycomed to accelerate $1.85million in payments to us in order to fund certain activities associated withthe qualification of our manufacturing facility.

**EuropeanCollaboration Agreement**

In July 2004, weentered into a collaboration, license and supply agreement with Nycomedpursuant to which we granted Nycomed rights to develop and market AI-700in Europe. As part of the agreement, Nycomed has agreed to provide up to$70 million in license fees, research and development funding, andmilestone payments, including $12 million in payments over the first twoyears, of which $11 million was received by us prior to March 31, 2006with the remaining $1 million paid to us in April 2006. The remaining$58 million in milestone payments are related to regulatory approvals andachievement of certain sales goals. In addition, Nycomed 

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has agreed to pay us tomanufacture AI-700 for them and to pay us royalties on Nycomed’s sales ofAI-700. Nycomed will be responsible for sales, marketing and theregulatory submissions required for marketing throughout its sales territory,which includes the member states of the European Union, as well as Russia/CISand Turkey.

In October 2005, weand Nycomed agreed to amend the strategic collaboration agreement in order toaccelerate $150,000 in milestone payments to support activities associated withAI-700 brand development, including related international trademarkactivities. In February 2006, we and Nycomed further amended the agreementto accelerate $1.85 million in milestone payments in order to fund certainactivities associated with the qualification of our manufacturing facility.Beginning with costs incurred in February 2006, we may begin to draw downon this $1.85 million in accelerated funding up to $370,000 per month. Anypayments received pursuant to these amendments are considered advances againsta future milestone payment for a European regulatory filing, or MarketingAuthorization Application (“MAA”), and will be deducted from that milestonepayment. Payments received under these amendments will be classified asdeferred revenue until the MAA milestone is achieved, provided that theapplicable revenue recognition criteria are met. As of March 31, 2006, wehave recorded accounts receivable of $370,000 for qualification costs invoicedto Nycomed, and have included this amount in deferred revenue.

The Nycomed agreement issubject to termination provisions. Under certain of these terminationprovisions, if we fail in any material respect to use all commerciallyreasonable efforts to carry out referenced obligations under the agreement, wewould be obligated to pay Nycomed liquidated damages of   up to $12 million. We plan tocarry out all of these obligations, which we believe are in our control. Therecan be no assurance that termination of this agreement will not occur or thatsuch termination would not result in us incurring liquidated damages of up to$12 million.

**FinancialOperations Overview**

*Revenue.*  We have not generated any revenue from productsales since our inception. In connection with our collaboration agreement withNycomed, as of March 31, 2006 we have received $11.0 million inlicense fees and research and development payments and we received the final$1.0 million in such research and development payments in April 2006. Weare recognizing this $12.0 million of initial license and research anddevelopment payments ratably over a period of forty-two months, representingthe development period, over which we are obligated to perform services underthe agreement.

In connection with ourfeasibility study discussed under early stage development programs below, wehave received $100,000 in payments which have been included in deferred revenueat March 31, 2006. Contract amounts which are not due until the customeraccepts or verifies the research results are not recognized as revenue untilpayment is received or the customer’s acceptance or verification of the resultsis evidenced, whichever occurs earlier.

Further in the future, wewill seek to generate revenue from a combination of product sales, up-front ormilestone payments and manufacturing payments in connection with collaborativeor strategic relationships, and royalties resulting from the license of ourproducts and intellectual property.

*Researchand Development Expense.*  Research and developmentexpense consists of expenses incurred in developing, manufacturing and testingproduct candidates. These expenses consist primarily of salaries and relatedexpenses for personnel, fees paid to professional service providers inconjunction with independently monitoring our clinical trials and acquiring andevaluating data in conjunction with our clinical trials, costs of materialsused in clinical trials and research and development, depreciation of capitalresources used to develop our products, costs of facilities, the legal costs ofpursuing patent protection on select elements of our intellectual property andstock-based compensation. We expense research and development costs, includingpatent related costs, as incurred. We believe that significant investment inproduct development is a competitive necessity and plan to continue theseinvestments in order to realize the potential of our product candidates andproprietary technologies. Development programs for later stage productcandidates, such as AI-700, tend to cost more than earlier stage programsdue to the length and the number of patients enrolled in clinical trials forlater stage programs and due to costs of scaling production to commercialscale.

*Generaland Administrative Expense.*  General andadministrative expense consists primarily of salaries and other related costsfor personnel in executive, finance, accounting, information technology,business development and human resource functions. Other costs include facilitycosts not otherwise included in research and development expense, professionalfees for legal and accounting services and stock-based compensation.

*InterestIncome.*  Interest income consists of interestearned on our cash and cash equivalents.

*InterestExpense.*  Interest expense consists of interestincurred on equipment leases and other financing arrangements. Interest expensealso includes interest recognized in connection with embedded derivatives.

*Changein Valuation of Derivative.*  The terms of our February 2005convertible perferred stock offering and our March 2005 Mass Developmentloan agreement contain features considered to be embedded derivatives which arerecorded at estimated fair value in accordance with Statement of FinancialAccounting Standards No. 133, Accounting for Derivative Instruments(SFAS 133). Change 

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in valuation ofderivative consists of other income (expense) recognized on the change in fairvalue of the derivative at the end of each reporting period. The change in thevalue of the derivative related to the preferred stock is affected by a numberof assumptions including the number of preferred shares outstanding, the amountof dividends paid and the probability and timing of conversion into commonstock. The derivative liability is reduced for any make-whole payments madeduring the period upon conversions of preferred stock to common stock. Thechange in the value of the derivative related to the loan is affected by theexpected timing of future positive net cash flows from operations.

*Dividendson Preferred Stock.* Dividends on preferred stock consisted ofdividends paid or accumulated on the convertible exchangeable preferred stockwhich we issued in February 2005. Dividends on preferred stock exclude anymake-whole payments on conversion of preferred stock to common stock. Dividendson our preferred stock are cumulative from the date of original issue at theannual rate of $3.25 per share, payable quarterly on the first day of March,June, September, and December. Any dividend payment must be declared by ourboard of directors and must come from funds that are legally available fordividend payments.

**Resultsof Operations**

*ThreeMonths Ended March 31, 2006 and 2005*

*Revenue.*  Collaboration revenue earned under our agreementwith Nycomed was $0.9 million for the three months ended March 31,2006 and for the three months ended March 31, 2005.

*Research and Development Expense.*  Researchand development expense for the three months ended March 31, 2006increased $3.2 million, or 42%, to $10.9 million versus $7.7 million in theprior year period. The increase was due primarily to higher costs associatedwith our new manufacturing facility which was substantially completed in late2005, primarily the depreciation of leasehold improvements, higher levels ofraw material purchases, higher stock-based compensation expense from theadoption of FAS 123R, and higher personnel costs due to increased headcount.  These expense increases were partially offsetby lower expenses associated with our clinical trials, versus the prior yearperiod. Clinical trial enrollment was lower than the prior year due to thecompletion of enrollment in the RAMP 1 trial in December 2005.

The following tablesummarizes the primary components of our research and development expense forthe three months ended March 31, 2006 and 2005:

|                          | ** ** | **March 31, 2006** | ** ** | **March 31, 2005** | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|
| Total direct  costs      |       | $                            | 7,077      |                         | $          | 5,904 |   |
| Indirect Costs:          |       |                         |       |                         |       |
| Facility costs           |       | 1,088                        |       | 1,056                        |       |
| Depreciation             |       | 2,458                        |       | 499                          |       |
| All other indirect costs |       | 250                          |       | 219                          |       |
| Total indirect  costs    |       | 3,796                        |       | 1,774                        |       |
| Total R&D            |       | $                            | 10,873     |                         | $          | 7,678 |   |

 

We intend to demonstratethat we can produce AI-700 on a commercial manufacturing scale prior tothe filing of our NDA for AI-700. We expect to incur higher expense forthe commercial manufacturing facility versus the prior year due to timing ofdepreciation expense and costs for the ongoing validation of the facility andits equipment, the purchase of raw materials and laboratory supplies and the hiringof additional personnel. Research and development costs generally increase asprograms progress from early stage clinical trials to late stage clinicaltrials. Our primary research and development programs are as follows:

*LateStage Clinical Development Program*. Our late stage clinicaldevelop program relates to our lead product candidate, AI-700, which is acardiovascular drug for the detection of coronary heart disease. Almost all ofour direct research and development expenditures for the three months ended March 31,2006 and 2005 relate to our AI-700 program.

*EarlyStage Clinical Development Programs*. The initial clinicalapplications of our HDDS technology, AI-850, and our PDDS technology, AI-128,have each completed a Phase 1 trial. In late 2005, we commenced a feasibilitystudy regarding the use of our HDDS technology in connection with a productcandidate under development by a large pharmaceutical company. Revenuegenerated under this feasibility study will be deferred until the contract hasbeen completed. During 2006 the costs of early stage development programs couldincrease, depending upon the extent to which we are successful in commencingnew feasibility studies with partners, if at all.

*Generaland Administrative Expense.*  General and administrativeexpense for the three months ended March 31, 2006 increased $0.9 million,or 53%, to $2.6 million versus $1.7 million in the prior year period. Theincrease was primarily due to additional stock-based compensation expense fromthe adoption of FAS 123R, higher consulting expense related to businessdevelopment activity and higher personnel costs due to increased headcount.

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The following tablesummarizes the primary components of our general and administrative expense forthe three months ended March 31, 2006 and 2005:

|                       | ** ** | **March 31, 2006** | ** ** | **March 31, 2005** | ** ** |
|-----------------------|------------|------------------------------|------------|------------------------------|------------|
| Total direct  costs   |       | $                            | 2,367      |                         | $          | 1,656 |   |
| Indirect Costs:       |       |                         |       |                         |       |
| Facility costs        |       | 140                          |       | 63                           |       |
| Depreciation          |       | 47                           |       | 28                           |       |
| Total indirect  costs |       | 187                          |       | 91                           |       |
| Total G&A         |       | $                            | 2,554      |                         | $          | 1,747 |   |

 

We anticipate an increasein general and administrative expense during 2006 from personnel costs forincreased headcount, in costs for stock-based compensation expense under FAS123R, for business development activities to support product developmentefforts, investor relations and other activities.

*InterestIncome.*  Interest income for the three monthsended March 31, 2006 increased $0.2 million, or 58%, to $0.5 millionversus $0.3 million in the prior year period. The increase was primarily due tohigher average cash balances during the period.

*InterestExpense.*  Interest expense for the three monthsended March 31, 2006 increased to $0.5 versus $0.1 million in prior yearperiod.  The increase was primarily dueto higher cumulative borrowings during the period under our equipment financinglines.

*Changein Valuation of Derivative.*   The change in thevaluation of derivative resulted in expense of $0.9 million during the threemonths ended March 31, 2006 versus income of $0.4 million in the prior yearperiod. As of March 31, 2006 and December 31, 2005, the derivativeliability was valued at approximately $2.0 million and $1.1 million,respectively.

**Liquidityand Capital Resources**

Historically, aside frompayments received in connection with our strategic collaboration with Nycomed,we have financed our business through the issuance of equity securities, debtfinancings and equipment leases. Our liquidity requirements have arisenprimarily from research and development expenditures, leasehold improvements,equipment expenditures and payments on outstanding indebtedness. As of March 31, 2006 we owed $85,000 from capital leasesand $21.8 million from notespayable and other long-term obligations. We also had operating leasecommitments totaling $14.6 millionfor rent of  our facilities. During thethree months ended March 31, 2006, operating activities used $12.9 millionof cash. Net cash used by operating activities during this period resultedprimarily from a net loss of $13.5 million, a decrease in accounts payableof $2.2 million, a decrease in accrued expenses of $1.0 million, non-cashamortization of deferred revenue of $0.9 million and a decrease of othercurrent assets of $0.4 million. These uses of cash were partially offset bynon-cash charges for depreciation and amortization of $2.6 million, anon-cash change in the valuation of derivative of $0.9 million, and non-cashstock-based compensation of $0.7 million.

During the three monthsended March 31, 2006, investing activities used $0.3 million in cash. Thisuse of cash was primarily for purchases of equipment related to expansion ofour manufacturing operations for AI-700. We intend to seek financing forfuture equipment purchases under additional secured lines of credit.

During the three monthsended March 31, 2006, financing activities used $0.1 million in cash.Net cash used by financing activities during this period resulted primarilyfrom net borrowings under equipment financing lines of $0.4 million offsetby a dividend payment on the redeemable convertible preferred stock of $0.6million. We also received proceeds of $0.1 million from the exercise of stockoptions and issuance of common stock under the ESPP.

On April 6, 2006,the Company sold 5,772,004 units, each unit consisting of (i) share ofcommon stock and (ii) one warrant to purchase 0.3 shares of common stockat an exercise price of $7.97 per share, for a purchase price of $6.9675 perunit, resulting in aggregate gross proceeds to the Company of $40.2 million(net proceeds of approximately $37.8 million after deducting underwritingdiscounts and commissions and estimated offering expenses). Units are notissued or certificated. The shares of common stock and warrants are immediatelyseparable and will be issued separately. The warrants will be exercisablebeginning on October 12, 2006 and until April 12, 2011.

We believe, based on ouroperating plans, that our existing resources, including scheduled proceeds fromNycomed, and proceeds from the above described equity financing completed in April 2006,will be adequate to fund our planned operations for at least the 

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next twelve months. In the future, we will requiresignificant additional funds to develop, conduct clinical trials, achieveregulatory approvals, qualify and improve commercial manufacturing space and,subject to regulatory approval, commercially launch AI-700, our otherproduct candidates under development and future product candidates. Our futurecapital requirements will depend on many factors, including the scope and progressmade in our research and development activities and our clinical trials and thesize and timing of creating expanded manufacturing capabilities. We may alsoneed additional funds for possible future strategic acquisitions of businesses,products or technologies complementary to our business. We do not expect togenerate significant revenues for AI-700, other than possible license ormilestone payments, unless or until we or current or potential partnerscomplete clinical trials and receive marketing approval from the applicableregulatory authorities. When additional funds are required or, in advance ofsuch requirements, when we anticipate that funds will be needed, we may raisesuch funds from time to time through public or private sales of equity or fromborrowings or we may delay funding of certain development activities whichcould delay the filing of our AI-700 NDA and the commercialization of AI-700which would have a materially adverse impact on our growth plans. Additionalequity financing may be dilutive to our stockholders and debt financing, ifavailable, may involve significant cash payment obligations and covenants thatrestrict our ability to operate as a business.

**UniversalShelf Registration Statement**

We have on file with theU.S. Securities and Exchange Commission (“SEC”) a “universal shelf”registration statement on Form S-3 (Registration No. 333-123854)which, when combined with our previously filed universal shelf registrationstatement on Form S-3, provides for the offer, from time to time, ofcommon stock, preferred stock, debt securities and warrants up to an aggregateof approximately $27.0 million. The SEC declared the shelf registrationstatement effective on April 15, 2005. In April 2006, we offered forsale approximately $40.2 million in common stock under this registrationstatement, thereby taking down the availability under this universal shelf tothe present level of $27.0 million. As of the filing of this report, the shelfregistration statement remains effective and, subject to market conditions andour capital needs, and so long as we are then eligible to use the registrationstatement under SEC rules, we may again seek to use any remaining availabilityunder the shelf registration statement by making an offering of securitiescovered for sale under the registration statement. In addition, we may amendour shelf registration statement or file a new shelf registrationstatement to increase our potential access to capital. If we elect to raiseadditional capital using a shelf registration statement, we may use the netproceeds from the sale of these securities for general corporate purposes,which may include funding clinical trials, research and development, regulatoryactivities and the build-out of our commercial manufacturing facility inTewksbury, Massachusetts, acquisitions, including acquisitions of companies,products, intellectual property or other technology, repayment or refinancingof existing indebtedness, investments, capital expenditures, repurchase of ourcapital stock and for any other purposes that we may specify in any prospectussupplement.

**Off-BalanceSheet Financing Arrangements**

We currently donot have any special purpose entities or off-balance sheet financingarrangements other than operating leases.

**ContractualObligations**

The following tablesummarizes our contractual obligations as of March 31, 2006 and the effectsuch obligations are expected to have on our liquidity and cash flow in futureperiods:

**PaymentsDue by Period**
| **Contractual Obligations**                                  | ** ** | ** **              | ** ** | **Total  Obligations  All Years** | ** ** | **2006  Remaining** | ** ** | **2007  Through  2008** | ** ** | **2009  Through  2010** | ** ** | **After 2010** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|---------------------|------------|-------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                                        | ** ** | **(in thousands)** | ** ** |
| Capital lease  obligations (including interest)                   |       | $                       | 100        |                                   | $          | 18                  |       | $                       | 50         |                    | $          | 32                  |       | $ | — |   |
| Operating lease  obligations                                      |       | 14,602                  |       | 2,069                                  |       | 4,701               |       | 4,726                   |       | 3,106                   |       |
| Notes payable  (including interest)                               |       | 18,888                  |       | 4,068                                  |       | 11,365              |       | 3,455                   |       | —                  |       |
| Intellectual  property acquisition cost obligations               |       | 6,000                   |       | 3,000                                  |       | 3,000               |       |                    |       |                    |       |
| Purchase orders  for capital equipment and leasehold improvements |       | 126                     |       | 126                                    |       | —              |       | —                  |       | —                  |       |
| Total contractual cash  obligations                               |       | $                       | 39,716     |                                   | $          | 9,281               |       | $                       | 19,116     |                    | $          | 8,213               |       | $ | 3,106 |   |

 

Our operatinglease obligations relate to our facility leases.

**CriticalAccounting Policies and Estimates**

Our discussion andanalysis of our financial condition and results of operations are based on ourconsolidated financial statements, 

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which have been preparedin accordance with accounting principles generally accepted in the UnitedStates. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets, liabilitiesand expenses. On an on-going basis, we evaluate our estimates and judgments,including those related to accrued expenses, fair valuation of stock related tostock-based compensation and income taxes. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions. We believe the followingcritical accounting policies affect our more significant judgments andestimates used in the preparation of our consolidated financial statements.

*Revenue.* We recognize revenuefrom license arrangements in accordance with Staff Accounting Bulletin No. 104,Revenue Recognition (“SAB 104”) and FASB Emerging Issue Task Force Issue No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”).We recognize revenue from license payments not tied to achieving a specificperformance milestone ratably over the period over which we are obligated toperform services. The period over which we are obligated to perform services isestimated based on available facts and circumstances. We recognize revenue fromperformance payments, when such performance is substantially in our control andwhen we believe that completion of such performance is reasonably probable,ratably over the period over which we estimate that we will perform suchperformance obligations. Substantive at-risk milestone payments, which arebased on achieving a specific performance milestone when performance of suchmilestone is contingent on performance by others or for which achievement cannot be reasonably estimated or assured, are recognized as revenue when themilestone is achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone. We do notrecognize revenue in connection with license arrangements until payments arecollected or due and reasonably assured of being collected. In addition, we donot recognize revenue in circumstances where the arrangement includes a refundprovision until the refund condition is no longer applicable unless, in ourjudgment, the refund circumstances are within our operating control andunlikely to occur. Payments received in advance of being recognized as revenueare deferred.

In connection with ourfeasibility study, contract amounts which are not due until the customeraccepts or verifies the research results are not recognized as revenue untilpayment is received or the customer’s acceptance or verification of the resultsis evidenced, whichever occurs earlier.

We are recognizingcollaboration revenue of $12.0 million associated with the initial license andperformance-based payments under the Nycomed agreement based on an estimatedrecognition period of forty-two months over which we are obligated to performservices supporting the agreement and assumes that AI-700 will be readyfor commercialization before the end of 2007. This estimated recognition periodmay change if available facts and circumstances change. Were the estimateddevelopment period to be extended, we would record a reduction in cumulativerevenue recognized in our statement of operations in the period in which thechange in development period is determined. Our agreement with Nycomed has beenmodified such that Nycomed has paid us $150,000 for activities associated withcreating a brand name for AI-700 and related trademark activities and toreimburse us for up to $1.8 million for support of activities to support thevalidation of the our commercial manufacturing facility for AI-700. Theseamounts were originally scheduled to be paid to us upon Nycomed’s filing forregulatory approval of AI-700 in Europe. While the amounts are notrefundable, we plan to defer recognition of these amounts until after the originalregulatory filing milestone has been achieved. Payments received for currentand potential HDDS and PDDS feasibility studies, which are offset by costsincurred for such studies, are recognized as revenue over the estimatedperformance period of each such study. A change in these estimates could resultin a significant change to the amount of revenue recognized in future periods.In addition, if the Nycomed collaboration agreement is terminated for reasonsother than certain non-performance by us, we would recognize the remainder ofthe payments we have received or otherwise expect to collect over theamortization period at the time of termination. We will not recognize revenueassociated with the potential additional $56 million in milestone-based paymentsthat may be earned under the Nycomed agreement until the underlying regulatoryand sales milestones are achieved.

*Propertyand Equipment.* Property and equipment are recorded at costand depreciated over their estimated useful lives of three to five years usingthe straight-line method. The majority of our equipment is related to ourongoing research and development activities, including equipment which, subjectto regulatory approvals, we intended to use for commercial manufacture of AI-700.We consider that this equipment is placed in service when operation of theequipment is started-up and begin depreciating the equipment at this time. Theequipment in our commercial manufacturing facility is currently undergoingresearch and development related activities that result in wear and tear on theequipment including include ongoing calibration and testing.

Leasehold improvementsand equipment under capital leases are recorded at cost. We depreciateleasehold improvements and equipment under capital leases over the lesser oftheir useful lives or the remainder of their respective lease terms. Duringperiods of leasehold build-out, we record such costs as construction inprogress and do not begin depreciation of such costs until the improvements aresubstantially completed and available for use. We began depreciation ofleasehold improvements at our Tewksbury facility in October 2005 uponreceipt of an occupancy permit and taking occupancy of the facility. Ourleasehold improvements costs on this facility approximate $23.6 million and arebeing depreciated ratably over remaining term of our present lease which isscheduled in expire in April 2010. We believe that the use of the originalterm of the lease for the depreciation period, rather than assuming that thelease term is renewed, is appropriate given the inherent uncertainties with aproduct such as AI-700, which has not yet completed its phase 3 clinicaltrials and requires regulatory approvals before it can be marketed. The RiskFactors included under 

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Section 1A of thisdocument discuss the uncertainties associated with AI-700.

*AccruedExpenses.* As part ofthe process of preparing consolidated financial statements we are required toestimate accrued expenses. This process involves identifying services whichhave been performed on our behalf and estimating the level of service performedand the associated cost incurred for such service as of each balance sheet datein our consolidated financial statements. Examples of estimated expenses forwhich we accrue include professional service fees, such as lawyers andaccountants, and contract service fees such as amounts paid to clinicalmonitors, data management organizations and investigators in conjunction withclinical trials, and fees paid to the engineering and construction managementcontractor used in the build-out of our commercial manufacturing facility forAI-700. In connection with such service fees, our estimates are mostaffected by our understanding of the status and timing of services providedrelative to the actual levels of services incurred by such service providers.The majority of our service providers invoice us monthly in arrears forservices performed. In the event that we do not identify certain costs whichhave begun to be incurred or we under- or over-estimate the level of servicesperformed or the costs of such services, our reported expenses for such periodwould be too low or too high. The date on which certain services commence, thelevel of services performed on or before a given date and the cost of suchservices are often judgmental. We make these judgments based upon the facts andcircumstances known to us in accordance with accounting principles generallyaccepted in the United States of America.

*Stock-BasedCompensation and Other Equity Instruments.* We account for stock-based compensation inaccordance with the fair value recognition provisions of FAS 123R. UnderFAS 123R, stock-based compensation cost is measured at the grant datebased on the value of the award and is recognized as expense over theappropriate vesting period. Determining the fair value of stock-based awards atthe grant date requires judgment, including estimating the expected term ofstock options, the expected volatility of our stock and expected dividends. Inaddition, judgment is required in estimating the amount of stock-based awardsthat are expected to be forfeited. If actual results differ significantly fromthese estimates or different key assumptions were used, it could have amaterial effect on our Consolidated Financial Statements. See Note 3 ofthe Notes to the Consolidated Financial Statements for additional informationregarding stock-based compensation expense.

Prior to adopting theprovisions of FAS 123R, the Company recorded estimated compensation expense foremployee stock options based upon their intrinsic value on the date of grantpursuant to Accounting Principles Board Opinion 25 (APB 25), “Accounting forStock Issued to Employees” and provided the required pro forma disclosures ofFAS 123. Because the Company established the exercise price based on the fairmarket value of the Company’s stock at the date of grant, the stock options hadno intrinsic value upon grant, and therefore no estimated expense was recordedprior to adopting FAS 123R. Each accounting period, the Company reported thepotential dilutive impact of stock options in its diluted earnings per commonshare using the treasury-stock method.

*DerivativeLiabilities.* The termsof our February 2005 convertible preferred stock offering and our March 2005MassDevelopment loan agreement contain features considered to be embeddedderivatives which are recorded at estimated fair value in accordance withStatement of Financial Accounting Standards No. 133, Accounting for DerivativeInstruments (SFAS 133). The estimation of this fair value includes variousassumptions and estimates, including assumptions and estimates of risk freeinterest rates, stock price volatility and the timing of future preferred stockconversions. Changes in these estimates and assumptions can increase ordecrease the value of this derivative liability. Changes in the fair value ofthe derivative financial instrument are included in other income (expense). Theconvertible preferred stock terms include a dividend make-whole paymentprovision, which has been initially recorded at its estimated fair value. Thisderivative liability is reduced upon conversion of the preferred stock as wellas dividends declared by our board of directors, if any. The MassDevelopmentloan agreement includes a provision for a retroactive interest rate increase inthe event that we achieve certain defined positive operating cash flows. Theinitial fair value of the MassDevelopment loan derivative is being amortizedover a term beginning with the loan agreement effective date and ending withthe estimated payment date of the retroactive interest. The fair value of bothderivative liabilities are re-measured at each reporting period.

*IncomeTaxes.* As part of theprocess of preparing our consolidated financial statements we are required toestimate our income taxes in each of the jurisdictions in which we operate.This process involves us estimating our actual current tax exposure togetherwith assessing temporary differences resulting from differing treatments ofitems for tax and accounting purposes. These differences result in deferred taxassets and liabilities. In addition, as of December 31, 2005, we hadfederal tax net operating loss carryforwards of $53.6 million, whichexpire through 2024. We also have research and development credit carryforwardsof $6.1 million. We have recorded a valuation allowance to fully offsetagainst these otherwise recognizable net deferred tax assets due to theuncertainty surrounding the timing of the realization of the tax benefit. Inthe event that we determine in the future that we will be able to realize allor a portion of its net deferred tax benefit, an adjustment to deferred taxvaluation allowance would be recorded in net income in the period in which sucha determination is made. The Tax Reform Act of 1986 contains provisions thatmay limit the utilization of net operating loss carryforwards and creditsavailable to be used in any given year in the event of significant changes inownership interest, as defined.

**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

We have not usedderivative financial instruments for speculative or trading purposes. However,we are exposed to market risk related to changes in interest rates. Our currentpolicy is to maintain an investment portfolio consisting mainly of U.S. moneymarket and government-grade securities, directly or through managed funds, withmaturities of one year or less. Our cash is deposited in and 

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invested through highlyrated financial institutions in North America. Our short-term investments aresubject to interest rate risk and will fall in value if market interest ratesincrease. If market interest rates were to increase immediately and uniformlyby 10% from levels at March 31, 2006, we estimate that the fair value ofour investment portfolio would decline by an immaterial amount. We currentlyhave the ability to hold our fixed income investments until maturity, andtherefore we do not expect our operating results or cash flows to be affectedto any significant degree by the effect of a change in market interest rates onour investments. Our equipment loans and capital leases are not subject tointerest rate fluctuations because the interest rates are fixed at the time ofborrowing.

**Effectsof Inflation**

Our assets are primarilymonetary, consisting of cash, cash equivalents and short-term investments.Because of their liquidity, these assets are not directly affected byinflation. We also believe that we have intangible assets in the value of ourtechnology. In accordance with generally accepted accounting principles, wehave not capitalized the value of this intellectual property on ourconsolidated balance sheet. Due to the nature of this intellectual property, webelieve that these intangible assets are not affected by inflation. Because weintend to retain and continue to use our equipment, furniture and fixtures andleasehold improvements, we believe that the incremental inflation related to replacementcosts of such items will not materially affect our operations. However, therate of inflation affects our expenses, such as those for employee compensationand contract services, which could increase our level of expenses and the rateat which we use our resources.

**ITEM 4. CONTROLSAND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

As of March 31, 2006(the “Evaluation Date”), the Company’s management, with the participation ofthe Company’s Chief Executive Officer and the Company’s Chief FinancialOfficer, evaluated the effectiveness of the Company’s disclosure controls andprocedures pursuant to Rule 13a-15(b) promulgated under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”). Based uponthat evaluation, the Company’s Chief Executive Officer and the Company’s ChiefFinancial Officer concluded that, as of the Evaluation Date, the Company’sdisclosure controls and procedures were effective in ensuring that materialinformation required to be disclosed by the Company in the reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms, including ensuring that such materialinformation is accumulated and communicated to the Company’s management,including the Company’s Chief Executive Officer and the Company’s ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure. During the periods covered by this report, the Company was notsubject to the provisions of Section 404 of the Sarbanes-Oxley Act of2002.

**InternalControl Over Financial Reporting**

During the first quarterof 2006, there have been no changes in the Company’s internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

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**PART II.OTHER INFORMATION**

**ITEM 1. LEGALPROCEEDINGS**

None

**ITEM 1A. RISKFACTORS**

**CertainFactors Which May Affect Future Results**

*Ouroperating results and financial condition have varied in the past and may inthe future vary significantly depending on a number of factors. Except for thehistorical information in this report, the matters contained in this reportinclude forward-looking statements that involve risks and uncertainties. Thefollowing factors, among others, could cause actual results to differ materiallyfrom those contained in forward-looking statements made in this report andpresented elsewhere by management from time to time. Such factors, amongothers, may have a material adverse effect upon our business, results ofoperations and financial condition.*

*In Item****1A (“Risk Factors”) of our AnnualReport on Form 10-K for the fiscal year ended December 31,2005, which was filed with the Securitiesand Exchange Commission on March 20, 2006, we describe risk factorsrelated to the Company. For convenience,our updated risk factors are included below in this Item 1A. There have been nomaterial changes in our risk factors from those disclosed in Item 1A of ourAnnual Report on Form 10-K for the fiscal year ended December 31, 2005.*

**RisksRelated to Our Company**

***We have not generated any product revenue to date, have ahistory of operating losses and our capital resources are limited.***

We are focused on productdevelopment and we have not generated any revenue from commercial sales of ourproducts to date. We have incurred losses each year of our operations. In 2005,we had a net loss available to holders of common stock of $47.0 million,and in the three months ended March 31, 2006 we had a net loss availableto holders of common stock of $14.1 million. At March 31, 2006 we had anaccumulated deficit of $233.5 million. We expect our research anddevelopment, general and administrative and sales and marketing expenses willincrease over the next several years.

We expect to continue toincur losses and capital expenditures for the foreseeable future. We alsoanticipate cash out flow from debt repayment and payment of other obligations.We believe, based on our operating plans, that our existing resources,including scheduled proceeds from Nycomed, and proceeds from the abovedescribed equity financing completed in April 2006, will be adequate tofund our planned operations for at least the next twelve months. Unless wereduce our current rate of spending, we will require significant additionalfunds to fund our operations, including to develop products, conduct clinicaltrials, achieve regulatory approvals, qualify commercial manufacturing spaceand, subject to regulatory approval, commercially launch AI-700, ourother product candidates under development and future product candidates. Wemay raise this additional capital through public or private sales of equity, orfrom borrowings, or from strategic partners.

As a result of ourlimited capital resources, we may elect to delay the funding of certaindevelopment activities, including the filing of our NDA for AI-700, whichwould result in a delay in the commercialization of AI-700. Any suchdelay in the filing of an NDA or commercialization of AI-700 would have amaterial adverse impact on our business and would likely have a materialadverse effect on the market price of our common stock. To address our capitalneeds, we may elect to raise funds through public or private sales of equity orfrom borrowings or from strategic partners. Additional equity financing, if available,may be dilutive to our stockholders; debt financing, if available, may involvesignificant cash payment obligations and covenants that restrict our ability tooperate our business; and strategic partnerships, if available, may result inroyalties or other terms which reduce our economic potential from productsunder development. In addition, third parties may attempt to acquire us atvaluations our board of directors or stockholders may not find attractive. Ifour capital resources are not sufficient to fund our planned operations for atwelve month period at the time the audit for our 2006 financial results iscomplete, our auditor may require a going concern qualification in its auditreport be included in our audit report on Form 10-K. Any suchqualification would have a material adverse effect on our ability to raisecapital and would have a material adverse effect on the market price of ourcommon stock.

***We need to allocate significant amounts of our availablecapital resources to make payments on our outstanding indebtedness andequipment lease obligations, our patent transfer agreement with ScheringAktiengesellschaft and as dividends on our 6.5% convertible exchangeablepreferred stock, which in turn could reduce our financial flexibility andability to fund other activities.***

As of March 31,2006, we had approximately $21.9 million in aggregate principal indebtednessoutstanding related to capital lease 

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obligations, notespayable and other long-term obligations. As of March 31, 2006, we hadoutstanding 740,000 shares of our 6.5% convertible exchangeable preferredstock, which shares accrue cumulative cash dividends at the annual rate of$3.25 per share, payable quarterly on the first day of March, June, September,and December. These payments will:

·      reducethe availability of our capital to fund our clinical trials for AI-700,the build-out and qualification of our commercial manufacturing space inTewksbury, Massachusetts and for working capital and other general corporatepurposes and may require us, in order to meet these obligations, to delay orreduce expenditures or forego business opportunities; and

·      potentiallyimpair our ability to obtain additional financing.

·      Toaddress our capital needs, we may elect to raise funds through public orprivate sales of equity or from borrowings or from strategic partners.Additional equity financing, if available, may be dilutive to our stockholders;debt financing, if available, may involve significant cash payment obligationsand covenants that restrict our ability to operate as a business; and strategicpartnerships, if available, may result in royalties or other terms which reduceour economic potential from products under development.

***Failure to obtain regulatory approvals for our productcandidates under development, in particular our lead product candidate AI-700,would have a material adverse effect on our business.***

We must receiveregulatory approval of each of our product candidates before we cancommercialize or sell that product candidate. The pre-clinical laboratorytesting, formulation development, manufacturing and clinical trials of anyproduct candidates we develop independently or in collaboration with thirdparties, as well as the distribution and marketing of these product candidates,are regulated by numerous federal, state and local governmental authorities inthe United States, principally the FDA, and by similar agencies in othercountries. The development and regulatory approval process takes many years,requires the expenditure of substantial resources, is uncertain and subject todelays, and will thus delay our receipt of revenues, if any, from any of ourproduct candidates. We cannot assure you that our clinical trials willdemonstrate the safety and efficacy of any of our product candidates or willresult in marketable products. No product can receive FDA approval unless humanclinical trials show both safety and efficacy for each target indication inaccordance with FDA standards. A number of companies in the pharmaceutical andbiotechnology industries have suffered significant setbacks in late stageclinical trials even after achieving promising results in early stagedevelopment. In our Phase 3 clinical trials for AI-700, we are seeking todemonstrate non-inferiority compared to nuclear stress tests. In suchnon-inferiority trials we are required to show that the comparator treatmenthas been performed at an acceptable level. The clinical effectiveness ofnuclear stress tests may have improved since the time of our Phase 2 clinicaltrials. We therefore cannot assure you that the results from our Phase 2clinical trials for AI-700 will be predictive of results obtained in ourPhase 3 clinical trials.

Many of the patients inour AI-700 clinical trials have coronary heart disease. As part of our AI-700clinical trials, patients will be exposed to potential safety risks associatedwith a stress test, including risks associated with a pharmacological stressor,and AI-700. Given the nature of the AI-700 clinical trials,including administering AI-700 in Phase 3 to larger numbers of at-riskpatients and new clinical sites and administering AI-700 to patients withcoexisting disease, adverse events are expected to be encountered during theclinical trials. Adverse events are also likely to be encountered in clinicaltrials for our other products, which clinical trials also include at-riskpatients. When significant adverse events are detected and these events areattributable to our products, such events could delay, limit or prevent regulatoryagency approval.

Further, data obtainedfrom pre-clinical and clinical activities are subject to varyinginterpretations that could delay, limit or prevent regulatory agency approval.We cannot assure you that our Phase 3 plan for AI-700 will successfullyaddress the requirements of the FDA or that the results of the Phase 3 programwill establish the safety and efficacy of AI-700 sufficiently for us toobtain regulatory approval. We may also encounter delays, resulting from theneed to enroll more patients than we currently estimate for in our clinicaltrials. This may occur due to a variety of factors including our inability toenroll sufficient proportion of patients with and without disease that isconsistent with our estimated clinical trial enrollment, based on a higher thanexpected number of patients enrolled in the trials who are unevaluable becausetheir nuclear stress or angiography studies are not compliant with trialprotocol or based on a change in the sample size required by regulatory authoritiesto meet desired study endpoints. We may also encounter delays or rejectionsbased on our inability to enroll enough patients to complete our clinicaltrials.

We may encounter delaysor rejections based on changes in regulatory agency policies or personnelduring the period in which we develop a drug or the period required for reviewof any application for regulatory agency approval of a particular compound. In2004, changes went into effect in the regulation of clinical trials in Europeand are currently being implemented by the individual member states of theEuropean Union. Our continuing efforts to comply with these changes could leadto delays or rejections of our clinical trials. We also may encounter delays inthe event we are unable to produce clinical trial material in sufficientquantities and of sufficient quality to meet the schedule for our plannedclinical trials. In addition, we rely on a number of third parties, such asclinical research organizations, to help support the clinical trials byperforming independent clinical monitoring, data acquisition and dataevaluations. Any failure on the part of these third parties could delay theregulatory approval process.

Failure to obtainregulatory approval or any delay or setback in obtaining regulatory agencyapprovals could:

·      adverselyaffect our ability to market any drugs we develop independently or withcollaborative partners;

·      imposeadditional costs and diminish any competitive advantages that we may attain; or

·      adverselyaffect our ability to generate royalties.

In particular, failure toobtain approval or substantial delays in obtaining approval for our leadproduct candidate, AI-700, would delay 

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our receipt of productrevenues and would have a material adverse affect our business, financialcondition and results of operations. Our stock price would also be materiallyadversely affected.

We cannot be certain thatwe will obtain any regulatory approvals in other countries and the failure toobtain these approvals would have a material adverse affect on our business,financial condition and results of operations. In order to market our productsoutside of the United States, we and our current, and potential future,collaborative partners must establish and comply with numerous and varyingregulatory requirements of other countries regarding safety and efficacy. Theapproval procedures vary among countries and can involve additional producttesting and additional administrative review periods. The time required toobtain approval in other countries might differ from that required to obtainFDA approval. The regulatory approval process in other countries may includeall of the risks associated with obtaining FDA approval detailed above.Approval by the FDA does not ensure approval by the regulatory authorities ofother countries. In addition, many countries outside the United States requirea separate review process prior to marketing to determine whether theirnational health insurance scheme will pay for newly approved products, as wellas the price which may be charged for a product.

***We may need to enroll more patients in AI-700 Phase 3clinical trials, and any such additional enrollment would require additionalexpenditures, which may be material, and would likely result in a delay of oursubmitting an NDA with the FDA for AI-700.***

We are intentionallyblinded to efficacy data from our ongoing Phase 3 pivotal trials. Estimatingthe number of patients we need to enroll in our pivotal Phase 3 clinical trialin order to achieve statistical significance is difficult. We estimate thenumber of patients we need to enroll in our pivotal Phase 3 clinical trialsbased on a variety of factors, including our understanding and analysis ofprevious trial data for AI-700, our ongoing discussions with the FDA andour own knowledge and past experience in these and similar matters. However,these estimates are subject to risks and uncertainties, and there can be noassurance that our estimates will prove to be correct. For example, in April 2005,based in part on feedback from the FDA, we revised the statistical analysisplan from which we base our patient enrollment estimates. This revision had theeffect of increasing the number of patients we estimate to be needed tocomplete the Phase 3 clinical trials to approximately 700 patients. Continueddiscussions with the FDA could lead to other changes, including changesrelating to our statistical analysis plans. How, when or if the matters beingdiscussed are resolved may affect whether AI-700 is approved for theindication that we are seeking, the timing of such approval or whether AI-700is approved at all. These discussions could also lead to delays in the timingof the un-blinding of the data from our Phase 3 clinical trials and therefore,the public announcement of results from those trials. Patient enrollmentdepends on many factors, including the size and disease prevalence of thepatient population, the nature of the protocol, the proximity of patients toclinical sites, and the eligibility criteria for the study and the freedom tooperate with respect to intellectual property. Any such delays, or the need toenroll more patients, will likely result in increased costs, which may bematerial and would likely have a harmful effect on our financial position andresults of operations. The market price of our common stock may also bematerially adversely affected in response to any such delays.

***If we cannot raise additional capital on acceptable terms,we may be unable to complete planned clinical trials, obtain regulatoryapprovals or commercialize our product candidates.***

We will requiresubstantial future capital in order to continue to conduct the research anddevelopment, clinical and regulatory activities necessary to bring our productcandidates to market and to establish commercial manufacturing, marketing andsales capabilities. Our future capital requirements will depend on manyfactors, including:

·      theprogress of pre-clinical development and laboratory testing and clinicaltrials;

·      thetiming of construction and size to which we expand our manufacturingcapabilities;

·      thetime and costs involved in obtaining regulatory approvals;

·      thenumber of product candidates we pursue;

·      thecosts involved in filing and prosecuting patent applications and enforcing ordefending patent claims; and

·      theestablishment of selected strategic alliances and activities required forproduct commercialization.

We intend to seekadditional funding through strategic collaborations and may seek fundingthrough private or public sales of our securities or by licensing all or aportion of our technology. This funding may significantly dilute existingstockholders or may limit our rights to our technology.

We cannot assure you thatwe can obtain additional funding on reasonable terms, or at all. If we raiseadditional funds by issuing equity securities, our stock price may decline, ourexisting stockholders may experience significant dilution, and the newly issuedsecurities may have rights superior to those of our common stock. If we raiseadditional funds by issuing debt, we may be subject to limitations on ouroperations and such debt may have rights senior to the debentures, if issued.If we cannot obtain adequate funds, we may:

·      terminateor delay clinical trials for one or more of our product candidates;

·      delayour establishment of sales, marketing and/or manufacturing capabilities;

·      curtailsignificant product development programs that are designed to identify newproduct candidates;

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·      relinquishrights to our technologies or product candidates; and/or

·      terminateor delay build-out and commissioning of our commercial manufacturing facility.

***Our products, if approved, may fail to achieve marketacceptance.***

There can be no assurancethat any products we successfully develop, if approved for marketing, willachieve market acceptance or generate significant revenues. Each of our productcandidates is intended to replace or alter existing therapies or procedures,and hospitals, physicians or patients may conclude that these products are lesssafe or effective or otherwise less attractive than these existing therapies orprocedures. For example, our lead product candidate, AI-700, is acontrast agent for use in ultrasound imaging procedures which will compete withexisting nuclear imaging and stress echocardiography. Hospitals, physicians orpatients may prefer these existing procedures to AI-700 enhancedultrasound imaging. If our products do not receive market acceptance for anyreason, it would adversely affect our business, financial condition and resultsof operations. Further, our competitors may develop new technologies orproducts that are more effective or less costly, or that seem morecost-effective, than our products. We can give no assurance that hospitals,physicians, patients or the medical community in general will accept and useany products that we may develop.

***Claims by other parties that we infringe or havemisappropriated their proprietary technology may result in liability fordamages, royalties, or other payments, or stop our development andcommercialization efforts.***

Competitors and otherthird parties may initiate patent litigation against us in the United States orin foreign countries based on existing patents or patents that may be grantedin the future. Many of our competitors have obtained patents covering productsand processes generally related to our products and processes, and they mayassert these patents against us. Moreover, there can be no assurance that thesecompetitors have not sought or will not seek additional patents that may coveraspects of our technology. As a result, there is a greater likelihood of apatent dispute than would be expected if our competitors were pursuingunrelated technologies.

While we conduct patentsearches to determine whether the technologies used in our products infringepatents held by third parties, numerous patent applications are currentlypending and may be filed in the future for technologies generally related toour technologies, including many patent applications that remain confidentialafter filing. Due to these factors and the inherent uncertainty in conductingpatent searches, there can be no guarantee that we will not violate third-partypatent rights that we have not yet identified.

We know of U.S. andforeign patents issued to third parties that relate to aspects of our productcandidates. There may also be patent applications filed by these or otherparties in the United States and various foreign jurisdictions that relate tosome aspects of our product candidates, which, if issued, could subject us toinfringement actions. In particular, we are aware of U.S. and foreign patentsowned by third parties, including potential competitors, which arguably coveraspects of our AI-700 contrast agent. We and several of these partieshave been actively engaged in opposing the grant of European patents withclaims that arguably cover aspects of our AI-700 product. Parties maycontest patents in Europe prior to contesting the counterpart patents in theUnited States because of procedural differences between European and U.S.patent laws as well as economic considerations. There is a significantpossibility that one or more of these third parties will use litigation toassert their patents in the United States or Europe.

The owners or licenseesof these and other patents may file one or more infringement actions againstus. In addition, a competitor may claim misappropriation of a trade secret byan employee hired from that competitor. Any such infringement or misappropriationaction could cause us to incur substantial costs defending the lawsuit andcould distract our management from our business, even if the allegations ofinfringement or misappropriation are unwarranted. A need to defend multipleactions or claims could have a disproportionately greater impact. In addition,either in response to or in anticipation of any such infringement ormisappropriation claim, we may enter into commercial agreements with the ownersor licensees of these rights. The terms of these commercial agreements mayinclude substantial payments, including substantial royalty payments onrevenues received by us in connection with the commercialization of ourproducts. We have had discussions which lead us to believe that owners orlicensees with these rights are interested in out-licensing certain rights totheir patents. There can be no assurance that we will enter into any suchagreement or that, if we elect to enter into such agreements that we will beable to do so on terms which are acceptable. Payments under such agreementscould increase our operating losses and reduce our resources available fordevelopment activities. Furthermore, a party making this type of claim couldsecure a judgment that requires us to pay substantial damages, which wouldincrease our operating losses and reduce our resources available fordevelopment activities. A judgment could also include an injunction or othercourt order that could prevent us from making, using, selling, offering forsale or importing our products or prevent our customers from using ourproducts. If a court determined or if we independently concluded that any ofour products or manufacturing processes violated third-party proprietaryrights, our clinical trials could be delayed and there can be no assurance thatwe would be able to reengineer the product or processes to avoid those rights,or to obtain a license under those rights on commercially reasonable terms, ifat all.

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***If we are unable to protect our intellectual propertyrights, our competitors may develop and market products with similar featuresthat may reduce demand for our products, and we may be prevented fromestablishing collaborative relationships on favorable terms.***

The following factors areimportant to our success:

·      receivingpatent protection for our product candidates;

·      maintainingour trade secrets;

·      notinfringing on the proprietary rights of others; and

·      preventingothers from infringing our proprietary rights.

We will be able toprotect our proprietary rights from unauthorized use by third parties only tothe extent that our proprietary rights are covered by valid and enforceablepatents or are effectively maintained as trade secrets. We try to protect ourproprietary position by filing U.S. and foreign patent applications related toour proprietary technology, inventions and improvements that are important tothe development of our business. Because the patent position of pharmaceuticalcompanies involves complex legal and factual questions, the issuance, scope andenforceability of patents cannot be predicted with certainty. Patents, ifissued, may be challenged, invalidated or circumvented. Thus, any patents thatwe own or license from others may not provide any protection againstcompetitors. Our pending patent applications, those we may file in the future,or those we may license from third parties, may not result in patents beingissued. If issued, they may not provide us with proprietary protection orcompetitive advantages against competitors with similar technology.Furthermore, others may independently develop similar technologies or duplicateany technology that we have developed. The laws of many foreign countries donot protect our intellectual property rights to the same extent as do the lawsof the United States.

We also rely on tradesecrets, know-how and technology, which are not protected by patents, tomaintain our competitive position. We try to protect this information byentering into confidentiality agreements with parties that have access to it, suchas our corporate partners, collaborators, employees and consultants. Any ofthese parties may breach the agreements and disclose our confidentialinformation or our competitors might learn of the information in some otherway. If any trade secret, know-how or other technology not protected by apatent were to be disclosed to or independently developed by a competitor, ourbusiness and financial condition could be materially adversely affected.

***We may become involved in lawsuits and administrative proceedingsto protect, defend or enforce our patents that would be expensive and timeconsuming.***

In order to protect orenforce our patent rights, we may initiate patent litigation against thirdparties in the United States or in foreign countries. In addition, we have beenand continue to be subject to certain opposition proceedings conducted inpatent and trademark offices challenging the validity of our patents and maybecome involved in future opposition proceedings. The defense of intellectualproperty rights, including patent rights through lawsuits, interference oropposition proceedings, and other legal and administrative proceedings can becostly and can divert our technical and management personnel from their normalresponsibilities. Such costs increase our operating losses and reduce ourresources available for development activities. An adverse determination of anylitigation or defense proceedings could put one or more of our patents at riskof being invalidated or interpreted narrowly and could put our patentapplications at risk of not issuing.

Furthermore, because ofthe substantial amount of discovery required in connection with intellectualproperty litigation, there is a risk that some of our confidential informationcould be compromised by disclosure during this type of litigation. For example,during the course of this kind of litigation and despite protective ordersentered by the court, confidential information may be inadvertently disclosedin the form of documents or testimony in connection with discovery requests,depositions or trial testimony. This disclosure could materially adverselyaffect our business and financial results.

***We have never manufactured any of our product candidates incommercial quantities, and if we fail to develop an effective manufacturingcapability for our products, including our lead product candidate AI-700,we may be unable to commercialize these products.***

We have no experience inmanufacturing our products for commercial use and limited experience indesigning equipment for the manufacture of our products. We are working tostart-up and qualify operations at a commercial manufacturing facility inTewksbury, Massachusetts and to demonstrate that we can produce AI-700 ata commercial manufacturing scale prior to our filing of a NDA for AI-700and, subject to required regulatory approvals, we intend to manufacture AI-700in this facility for commercial use. We can not assure you that we will be ableto successfully manufacture our products in sufficient quantities forcommercial sale, or obtain the necessary regulatory approvals for suchcommercial manufacture, at all or in a timely or economical manner. Ourintention to manufacture AI-700 or other products exposes us to thefollowing risks, any of which could delay or prevent the approval of ourproducts by the FDA or corresponding state and foreign agencies, or thecommercialization of our products, or result in higher costs or inability tomeet demand for AI-700 leading to potential revenue loss, and any ofwhich would have a material adverse impact on our business, financial conditionand results of operations.

·      Manufacturersoften encounter difficulties in achieving volume production, quality controland quality assurance. Accordingly, we might not be able to manufacturesufficient quantities of drugs to meet our clinical schedules or tocommercialize our products.

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·      Manufacturersare obliged to manufacture in highly controlled environments and to operate inaccordance with FDA and international mandated current good manufacturingpractices, or cGMPs. For our clinical trials we have relied on contractmanufacturers for such facilities and cGMP compliance. In July 2004, weentered into a lease for a facility in Tewksbury, Massachusetts that we are inthe process of converting into a commercial manufacturing facility for AI-700.Creation and qualification of a commercial manufacturing environment requiressignificant expertise and capital resources, including the development ofadvanced manufacturing techniques and process controls and is subject to localand state planning approvals. Manufacturers of pharmaceutical products oftenencounter difficulties in constructing and qualifying new manufacturingfacilities and in production, especially in scaling-up initial production. Afailure within this new facility to establish and follow cGMPs and to documentadherence to such practices may lead to significant delays in the availabilityof material for our NDA filing or commercial production for AI-700 andmay delay or prevent filing or approval of marketing applications for ourproducts or the ability to continue to manufacture the products. Certain ofthese delays would further require us to continue to operate this facility andincur related costs.

·      Manufactureof our product candidates, in preparation for filing a NDA and for commercialproduction, will each initially require and rely on a single commercialmanufacturing site, directly or through a contract manufacturer, without thebackup of a second site that is qualified for commercial manufacture of theproduct. Qualification of another manufacturing site can be expensive and timeconsuming. Prior to using product from a new manufacturing site, we mustdemonstrate to the FDA and corresponding state and foreign agencies that thespecifications for the product are consistent with the specifications for theproduct as it was manufactured at a prior qualified site or we must clinicallyor otherwise demonstrate that the safety and efficacy of the product producedin the new manufacturing site is consistent with the product as it wasmanufactured at the prior site. Demonstrating such consistency may bedifficult, expensive or time consuming. In addition, before we would be able toproduce product for commercial use at a new facility, it will have to undergo apre-approval inspection by the FDA and corresponding state and foreignagencies. Once approved, drug manufacturers are subject to ongoing periodicunannounced inspection by the FDA and corresponding state and foreign agenciesto ensure strict compliance with cGMPs, other government regulations andcorresponding foreign standards. Failure to maintain compliance with cGMP orwith safety or environmental regulations could result in penalties, productrecalls or restrictions on the use of the manufacturing site.

Under the terms of ourcollaboration agreement with Nycomed, we are responsible for the commercialmanufacture of AI-700 for marketing and sale by Nycomed in Europe.Failure to manufacture AI-700 in a timely manner or on an economic basis,or in sufficient quantities, could jeopardize our relationship with Nycomed. Wedo not currently have a European sales force, nor do we have experience withregard to the commercialization, marketing, sale or distribution of pharmaceuticalproducts in Europe, and we rely entirely on Nycomed for this expertise. Anytermination of our relationship with Nycomed would have a material adverseimpact on our business, financial condition and results of operations.

***We may not be able to manufacture our products in commercialquantities, which would prevent us from marketing our products.***

To date our productcandidates have been manufactured in small quantities for pre-clinical andclinical trials. If any of these product candidates are approved by the FDA orforeign regulatory authorities for commercial sale, we will need to manufacturethem in larger quantities. For AI-700, it is our intention to seekregulatory approval after we have demonstrated that we can manufacture AI-700at a larger batch scale than is being used for clinical trial materials. Wecannot assure you that we will be able to successfully increase themanufacturing capacity or manufacture at a larger batch scale, whether on ourown or in collaboration with third party manufacturers, for any of our productcandidates in a timely or economic manner, or at all. Significant scale-up ofmanufacturing may require certain additional validation studies, which the FDAmust review and approve. If we are unable to successfully increase the manufacturingcapacity for a product candidate, the regulatory approval or commercial launchof that product candidate may be delayed or there may be a shortage in supplyof that product candidate. Our product candidates require precise, high-qualitymanufacturing. Our failure to achieve and maintain these high manufacturingstandards, including controlling the incidence of manufacturing errors andmaintaining reliable product packaging for diverse environmental conditions,could result in patient injury or death, product recalls or withdrawals, delaysor failures in product testing or delivery, cost overruns or other problemsthat could seriously hurt our business.

The Company’s commercialmanufacturing facility in Tewksbury, Massachusetts is designed to meet theCompany’s estimated initial commercial demand for AI-700. The facility isbeing initially equipped to run one production line. In order to supportgreater production capacity, this production line is designed to support alarger lyophilizer (pharmaceutical freeze dryer which can be operated understerile conditions) than has been initially installed in the facility. Space inthe facility has been designated for the future addition of a largerlyophilizer. Purchasing, installing and qualifying manufacturing equipment,such as a lyophilizer, typically requires significant lead times and temporarydiscontinuation of production. Also in the future the Company may need to addadditional production lines at the Tewksbury, Massachusetts site or elsewhereto meet potential commercial demand for AI-700. The Company has made nocommitment to such additions at this time. The cost of such additions can besignificant. There can be no assurance that the Company’s capacity estimateswill be achieved. Any such additions would increase our operating spending,increase our capital requirements and reduce our resources available fordevelopment activities.

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***We have removed our AI-700 manufacturing equipmentfrom the facilities of our third party contract manufacturer and currently haveno facility within which to manufacture AI-700 until the new commercialmanufacturing facility is qualified or until other arrangements are made.***

We have removed our AI-700manufacturing equipment from the facilities of a third-party contractmanufacturer. We believe that we have sufficient inventory of AI-700clinical trial material to complete our Phase 3 program. However, there can beno assurance that such inventory will prove sufficient or that the inventorywill not get damaged or otherwise disqualified. Currently, we have no facilitywithin which to manufacture AI-700 until the new commercial manufacturingfacility is qualified or until other arrangements are made. If we lacksufficient inventory of AI-700 clinical trial material to complete ourPhase 3 program or are unable to manufacture sufficient inventory on a timelybasis, our Phase 3 program could be delayed and would consequently delay ourability to commercialize AI-700. These delays could have a materialadverse effect on our business, financial condition and results of operations.

***If third-party manufacturers of our products fail to devotesufficient time and resources to our concerns, or if their performance issubstandard, our clinical trials may be delayed and our costs may rise.***

We may rely substantiallyon third-party contract manufacturers to supply, store and distribute ourpotential products for our clinical trials and other development needs. Ourreliance on these third-party manufacturers will expose us to the followingrisks, any of which could delay or prevent the completion of our clinicaltrials, the approval of our products by the FDA, or the commercialization ofour products, result in higher costs, or deprive us of additional productcandidates, and any of such effects would have a material adverse impact on ourbusiness, financial condition and results of operations.

·      Contractmanufacturers often encounter difficulties in achieving volume production,quality control and quality assurance, as well as shortages of qualifiedpersonnel. Accordingly, a manufacturer might not be able to manufacturesufficient quantities of drugs to meet our clinical schedules.

·      Contractmanufacturers are obliged to operate in accordance with FDA-mandated currentgood manufacturing practices, or cGMPs. A failure of these contractmanufacturers to establish and follow cGMPs and to document their adherence tosuch practices may lead to significant delays in the availability of materialfor clinical study and may delay or prevent filing or approval of marketingapplications for our products.

·      Forproduction of clinical trial material for each of our current productcandidates we will initially rely on a single manufacturer. Changing these orfuture manufacturers may be difficult and the number of potential manufacturersis limited. Changing manufacturers may require re-validation of themanufacturing processes and procedures in accordance with FDA-mandated cGMPs.Such re-validation may be costly and time-consuming. It may be difficult or impossiblefor us to find replacement manufacturers on acceptable terms quickly, or atall.

·      Ourcontract manufacturers may not perform as agreed or may not remain in thecontract manufacturing business for the time required to produce, store anddistribute our products successfully. Our manufacturing levels, while importantto us, can represent relatively small fractions of the overall business of mostqualified contract manufacturers. As a result, the contract manufacturers maynot provide us with the attention that we need or may be unwilling to adapt tonecessary changes in our manufacturing requirements.

Drug manufacturers aresubject to ongoing periodic unannounced inspection by the FDA and correspondingstate and foreign agencies to ensure strict compliance with cGMPs, othergovernment regulations and corresponding foreign standards. While we areobligated to audit the performance of third party contractors, we do not havecontrol over our third-party manufacturers’ compliance with these regulationsand standards. Failure by our third-party manufacturers or us to comply withapplicable regulations could result in sanctions being imposed on us, includingfines, injunctions, civil penalties, failure of the government to grant marketapproval of drugs, delays, suspension or withdrawal of approvals, seizures orrecalls of product, operating restrictions and criminal prosecutions, any ofwhich could significantly and adversely affect our business.

***Materials necessary to manufacture our products may not beavailable, which may delay our development and commercialization activities.***

Only a few facilitiesmanufacture some of the raw materials necessary to manufacture our products. Ifwe need to purchase a raw material that is in limited supply for our clinicaltrials, or for commercial distribution if we obtain marketing approval of aproduct candidate, we cannot assure you that one or more suppliers would beable to sell us that raw material at the time we need it and on commerciallyreasonable terms. If we change suppliers for any of these materials or any ofour suppliers experiences a shutdown or disruption in the facilities used toproduce these materials, due to technical, regulatory or other problems, itcould harm our ability to manufacture our products. Our inability to obtainrequired raw materials for any reason could substantially impair ourdevelopment activities or the production, marketing and distribution of ourproducts.

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***We have no experience selling, marketing or distributing ourproducts and no internal capability to do so.***

If we receive regulatoryapproval to commence commercial sale of any product, we will face competitionwith respect to commercial sales, marketing and distribution. These are areasin which we have no experience. To market any of our products directly, we mustdevelop a direct marketing and sales force with technical expertise andsupporting distribution capability. Alternatively, we may engage a pharmaceuticalor other healthcare company with an existing distribution system and directsales force to assist us. There can be no assurance that we will successfullyestablish sales and distribution capabilities either on our own or incollaboration with third parties or gain market acceptance for our products. Tothe extent we have or will enter co-promotion or other licensing arrangements,any revenues we receive will depend on the efforts of third parties and therecan be no assurance that our efforts will succeed.

***If we are unable to retain key personnel and hire additionalqualified scientific, manufacturing, sales and marketing, and other personnel,we may not be able to successfully achieve our goals.***

We depend on theprincipal members of our scientific and management staff. The loss of theseprincipal members’ services might significantly delay or prevent theachievement of research, development or business objectives and couldmaterially adversely affect our business, financial condition and results ofoperations. We do not maintain key person life insurance on any of theseprincipal members. On February 1, 2006, we entered into executiveemployment agreements with key members of the management team that provide forcompensation and other benefits in the event these persons are terminated otherthan for cause, including in connection with a “change of control” ofAcusphere.

Our success depends, inlarge part, on our ability to attract and retain qualified scientific andmanagement personnel such as these individuals. We face intense competition forsuch personnel and consultants. We cannot assure you that we will attract andretain qualified management and scientific personnel in the future.

Further, we expect thatour potential expansion into areas and activities requiring additionalexpertise, such as further clinical trials, governmental approvals, commercialmanufacturing and marketing, will place additional requirements on ourmanagement, operational and financial resources. We expect these demands willrequire an increase in management and scientific personnel and the developmentof additional expertise by existing management personnel. The failure toattract and retain such personnel or to develop such expertise could materiallyadversely affect prospects for our success.

***We will establish collaborative relationships, and thoserelationships may expose us to a number of risks.***

We will rely on a numberof significant collaborative relationships with pharmaceutical or otherhealthcare companies for our manufacturing, research funding, clinicaldevelopment and/or sales and marketing performance. Reliance on collaborativerelationships poses a number of risks, including the following:

·      wecannot effectively control whether our corporate partners will devotesufficient resources to our programs or product candidates;

·      disputesmay arise in the future with respect to the ownership of rights to technologydeveloped with collaborators;

·      disagreementswith collaborators could delay or terminate the research and development,regulatory approval or commercialization of product candidates, or result inlitigation or arbitration;

·      corporatepartners may have considerable discretion in electing whether to pursue thedevelopment of any additional product candidates and may pursue technologies orproducts either on their own or in collaboration with our competitors; and

·      collaboratorswith marketing rights may choose to devote fewer resources to the marketing ofour product candidates than they do to product candidates of their owndevelopment.

In July 2004, weentered into a collaboration, license and supply agreement with Nycomed inwhich we granted Nycomed rights to develop and market AI-700 in Europe.There can be no assurance that the regulatory goals, sales targets and otherobjectives of this agreement will be achieved. Failure to achieve these goals,targets and objectives would result in our inability to receive license,milestone, royalty and other payments under this agreement, which would have amaterial adverse impact on our business, financial condition and results ofoperations including, under certain conditions, reduction of royalty rates,delays in regulatory approvals and product sales, penalties and termination ofthe agreement. Under certain provisions of this collaboration agreement, if wefail in any material respect to use all commercially reasonable efforts tocarry out referenced obligations under the agreement, we would be obligated topay Nycomed liquidated damages of up to $12 million. Although we plan tocarry out all of these obligations, which we believe are in our control, therecan be no assurance that termination of this agreement will not occur or thatsuch termination would not result in us incurring liquidated damages of up to$12 million.

Given these risks, ourcurrent and future collaborative efforts may not be successful. Failure ofthese efforts could delay our product development or impair commercializationof our products, and could have a material adverse effect on our business,financial condition and results of operations.

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***Competition in the pharmaceutical industry is intense, andif we fail to compete effectively our financial results will suffer.***

We engage in a businesscharacterized by extensive research efforts, rapid developments and intensecompetition. We cannot assure you that our products will compete successfullyor that research and development by others will not render our productsobsolete or uneconomical. Our failure to compete effectively would materiallyadversely affect our business, financial condition and results of operations.We expect that successful competition will depend, among other things, onproduct efficacy, safety, reliability, availability, timing and scope ofregulatory approval and price. Specifically, we expect important factors willinclude the relative speed with which we can develop products, complete theclinical, development and laboratory testing and regulatory approval processesand supply commercial quantities of the product to the market.

We expect competition toincrease as technological advances are made and commercial applicationsbroaden. In commercializing our initial product candidates and any additionalproducts we develop using our HDDS and PDDS technologies, we will face substantialcompetition from large pharmaceutical, biotechnology and other companies,universities and research institutions.

·      AI-700,our ultrasound contrast agent and lead product candidate, if approved formarketing and sale, will compete with nuclear stress tests, the currentstandard of care in myocardial perfusion imaging. Nuclear contrast agents thatare approved for use in myocardial perfusion imaging include products marketedby GE Healthcare and Bristol-Myers Squibb. In 2004, the cost of a nuclear stresstest was approximately $770 per procedure. In addition, GE Healthcare andBristol-Myers Squibb have developed and are marketing ultrasound contrastagents that have been approved by the FDA for use in Left VentricularOpacification and Endocardial Border Delineation in patients with suboptimalimages, and in the future they may seek to broaden their products to includestress echo and myocardial perfusion assessment. Moreover, we are aware thatother companies, such as Bracco, are developing ultrasound contrast agents forwall imaging and for radiology applications, and that Point Biomedical isdeveloping an ultrasound contrast agent specifically for myocardial perfusionimaging. In 2006, Point announced that it had filed a NDA for CardioSphere withthe FDA. Finally, some cardiologists may find it satisfactory to use stressecho without contrast for the detection of coronary heart disease.

·     AI-850,our reformulation of paclitaxel, if approved for marketing and sale, will alsoface intense competition from companies such as American PharmaceuticalPartners, NeoPharm and Sonus Pharmaceuticals (in partnership with Schering AG),which are applying significant resources and expertise to developingreformulations of paclitaxel for intravenous delivery. American PharmaceuticalPartners has received FDA approval and is selling their product. Othercompanies, such as Cell Therapeutics, are developing new chemical entities thatinvolve paclitaxel conjugated, or chemically bound, to another chemical.

·      AI-128,our sustained release formulation of an asthma drug, if approved for marketingand sale, will also face intense competition. Companies such as Alkermespossess technology that may be suitable for sustained release pulmonary drugdelivery and may have competitive programs that have not been publiclyannounced or may decide to begin such programs in the future. In addition,large pharmaceutical companies that market FDA-approved asthma drugs may bedeveloping sustained release versions of their asthma drugs that would competewith our product candidates.

Relative to us, most ofour competitors have substantially greater capital resources, research anddevelopment staffs, facilities and experience in conducting clinical trials andobtaining regulatory approvals, as well as in manufacturing and marketingpharmaceutical products. Many of our competitors may achieve productcommercialization or patent protection earlier than we will.

Furthermore, we believethat some of our competitors have used, and may continue to use, litigation togain a competitive advantage. Finally, our competitors may use differenttechnologies or approaches to the development of products similar to theproducts we are seeking to develop.

***We expect to develop international operations that willexpose us to additional business risks.***

We expect, whetherdirectly or through collaborative relationships, to develop operations outsidethe United States in order to market and distribute our products. Regardless ofthe extent to which we seek to develop these operations ourselves or incollaboration with others, we cannot be sure that our international effortswill be successful. Any expansion into international markets will requireadditional resources and management attention and will subject us to new businessrisks. These risks could lower the prices at which we can sell our products orotherwise have an adverse effect on our operating results. Among the risks webelieve are most likely to affect any international operations are:

·      differentregulatory requirements for approval of our product candidates;

·      dependenceon local distributors;

·      longerpayment cycles and problems in collecting accounts receivable;

·      adversechanges in trade and tax regulations;

·      theabsence or significant lack of legal protection for intellectual propertyrights;

·      politicaland economic instability; and

·      currencyrisks.

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**RisksRelated to Our Industry**

***Even if we obtain marketing approval, our products will besubject to ongoing regulatory review.***

If regulatory approval ofa product is granted, such approval may be subject to limitations on theindicated uses for which the product may be marketed or contain requirementsfor costly, post-marketing follow-up studies. As to products for whichmarketing approval is obtained, the manufacturer of the product and themanufacturing facilities will be subject to continual review and periodicinspections by the FDA and other regulatory authorities. In addition, thelabeling, packaging, adverse event reporting, storage, advertising, promotionand record keeping related to the product will remain subject to extensiveregulatory requirements. The subsequent discovery of previously unknownproblems with the product, manufacturer or facility may result in restrictionson the product or the manufacturer, including withdrawal of the product fromthe market. We may be slow to adapt, or we may never adapt, to changes inexisting requirements or adoption of new requirements or policies.

If we fail to comply withapplicable regulatory requirements, we may be subject to fines, suspension orwithdrawal of regulatory approvals, product recalls, seizure of products,operating restrictions and criminal prosecution.

***Market acceptance of our products will be limited if usersof our products are unable to obtain adequate reimbursement from third-partypayors.***

Government healthadministration authorities, private health insurers and other organizationsgenerally provide reimbursement for products like our product candidates, andour commercial success will depend in part on these third-party payors agreeingto reimburse patients for the costs of our products. Even if we succeed inbringing any of our proposed products to market, we cannot assure you thatthird-party payors, in the United States, Europe and other markets that we maypursue, will consider our products cost-effective or provide reimbursement inwhole or in part for their use or agree to the proposed price.

Significant uncertaintyexists as to the reimbursement status of newly approved health care products.Each of our product candidates is intended to replace or alter existingtherapies or procedures. These third-party payors may conclude that ourproducts are less safe, effective or cost-effective than these existingtherapies or procedures. Therefore, third-party payors may not approve ourproducts for reimbursement.

If third-party payors donot approve our products for reimbursement or fail to reimburse themadequately, sales will suffer as some physicians or their patients will opt fora competing product that is approved for reimbursement or is adequatelyreimbursed. Even if third-party payors make reimbursement available, thesepayors’ reimbursement policies may adversely affect the ability of us and ourpotential collaborators to sell our products on a profitable basis.

Moreover, the trendtoward managed healthcare in the United States, the growth of organizationssuch as health maintenance organizations, and legislative proposals to reformhealthcare and government insurance programs could significantly influence thepurchase of healthcare services and products, resulting in lower prices andreduced demand for our products which could adversely affect our business,financial condition and results of operations.

In addition, legislationand regulations affecting the pricing of pharmaceuticals may change in waysadverse to us before or after the FDA or other regulatory agencies approve anyof our proposed products for marketing. While we cannot predict the likelihoodof any of these legislative or regulatory proposals, if any government orregulatory agencies adopt these proposals they could materially adverselyaffect our business, financial condition and results of operations.

***We may be required to defend lawsuits or pay damages inconnection with the alleged or actual harm caused by our products or productcandidates.***

We face an inherentbusiness risk of exposure to product liability claims in the event that the useof our products is alleged to have resulted in harm to others. This risk existsin clinical trials as well as in commercial distribution. In addition, thepharmaceutical and biotechnology industries in general have been subject tosignificant medical malpractice litigation. We may incur significant liabilityif product liability or malpractice lawsuits against us are successful.Furthermore, product liability claims, regardless of their merits, could becostly and divert our management’s attention from other business concerns, oradversely affect our reputation and the demand for our products. Although wemaintain product liability insurance, we cannot be certain that this coveragewill be adequate or that it will continue to be available to us on acceptableterms.

***Rapid technological change could make our products obsolete.***

Pharmaceutical technologieshave undergone rapid and significant change. We expect that pharmaceuticaltechnologies will continue to develop rapidly. Our future will depend in largepart on our ability to maintain a competitive position with respect to thesetechnologies. Any compounds, products or processes that we develop may becomeobsolete before we recover any expenses incurred in connection with theirdevelopment. Rapid technological change could make our products obsolete, whichcould materially adversely affect our business, financial condition and resultsof operations.

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***Our products involve the use of hazardous materials, and asa result we are exposed to potential liability claims and to costs associatedwith complying with laws regulating hazardous waste.***

Our research anddevelopment activities involve the use of hazardous materials, includingchemicals and biological materials. We believe that our procedures for handlinghazardous materials comply with federal and state regulations. However, therecan be no assurance that accidental injury or contamination from thesematerials will not occur. In the event of an accident, we could be held liablefor any damages, which could exceed our available financial resources. Thisliability could materially adversely affect our business, financial conditionand results of operations.

We are subject tofederal, state and local laws and regulations governing the use, manufacture,storage, handling and disposal of hazardous materials and waste products, andwe spent approximately $6,300 during the three months ended March 31, 2006to dispose of these hazardous materials and waste products. We may be requiredto incur significant costs to comply with environmental laws and regulations inthe future that could materially adversely affect our business, financialcondition and results of operations.

**RisksRelated to Our Common Stock**

***We expect that our stock price will fluctuate significantly.***

We completed our initialpublic offering in October 2003. Prior to this offering, you could not buyor sell our common stock publicly. After this offering, the average dailytrading volume for our common stock has been relatively low. An active publicmarket for our common stock may not continue to develop or be sustained. Thestock market, particularly in recent years, has experienced significantvolatility particularly with respect to pharmaceutical and biotechnologystocks. The volatility of pharmaceutical and biotechnology stocks often doesnot relate to the operating performance of the companies represented by thestock. Factors that could cause this volatility in the market price of ourcommon stock include:

·      announcementsof the introduction of new products by us or our competitors;

·      announcementsof clinical trial results;

·      marketconditions in the pharmaceutical and biotechnology sectors;

·      rumorsrelating to us or our competitors;

·      litigationor public concern about the safety of our potential products;

·      ourquarterly operating results;

·      deviationsin our operating results from the estimates of securities analysts;

·      sales by us of additional shares of ourcommon or preferred stock; and

·      FDAor international regulatory actions.

The market price of ourcommon stock may also fluctuate in response to the exercise by us of rightsunder the terms of our 6.5% convertible exchangeable preferred stock. Forexample, we may elect to automatically convert the preferred stock if ourcommon stock price has exceeded 150% of the conversion price of the preferredstock for at least 20 trading days during a 30-day trading period endingwithin five trading days prior to the notice of automatic conversion. There isa risk of fluctuation in the price of our common stock between the time when wemay first elect to automatically convert the preferred stock and the automaticconversion date. These fluctuations may adversely affect the value of ourcommon stock.

***Our controlling equity holders may have conflicts ofinterests with us or you in the future.***

As of May 9, 2006,and based on information provided to us by such entities: Quaker CapitalManagement Corporation and its affiliates beneficially own approximately 9% ofour outstanding common stock; Bank of America Corporation and its affiliatesbeneficially own approximately 7% of our outstanding common stock; the BaupostGroup LLC beneficially owns approximately 7% of our outstanding common stock;the Endowment Capital Group LLC and its affiliates beneficially ownapproximately 6% of our outstanding common stock and Mr. Peter David Boonebeneficially owns approximately 6% of our outstanding common stock.Collectively these investors will control approximately 35% of our commonstock. These investors, particularly if they were to act together as aconcentrated group, could exert influence over the election of our directors,direct our policies and operations, including future issuances of common stockor other securities, the payments of dividends, if any, on our common stock,the incurrence of debt by us, amendments to our Amended and RestatedCertificate of Incorporation and Amended and Restated Bylaws and entering intoof extraordinary transactions, and their interests, as a concentrated group,may not in all cases be aligned with your interests. This concentration ofownership among a small number of investors may make it more difficult forother stockholders to influence matters requiring stockholder approval and mayhave the effect of delaying, preventing or deterring a change in control of ourcompany, thereby possibly depriving our stockholders of an opportunity toreceive a premium for their common stock as part of any sale or acquisition.

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***Our common stock is junior to our preferred stock withrespect to the right to receive payments in the event of a dissolution,liquidation or winding up of Acusphere.***

In February 2005, weissued and sold 900,000 shares of our 6.5% convertible exchangeable preferredstock. As of May 9, 2006, 730,000 of these shares of preferred stock areoutstanding. The preferred stock is senior to the common stock as toliquidation. In the event of our voluntary or involuntary dissolution,liquidation or winding up of Acusphere, holders of our preferred stock willreceive a liquidation preference in an amount equal to $50 per share, plus allaccrued and unpaid dividends through the distribution date. Only after holdersof the preferred stock have received their liquidation preference and anyaccrued and unpaid dividends will we distribute assets, if any are remaining,to our common stock holders.

***We may be the subject of securities class action litigationdue to future stock price volatility.***

In the past, when themarket price of a stock has been volatile, holders of that stock have ofteninstituted securities class action litigation against the company that issuedthe stock. If any of our stockholders brought a lawsuit against us, we couldincur substantial costs defending the lawsuit. The lawsuit could also divertthe time and attention of our management.

***Future sales of common stock by our existing stockholdersmay cause our stock price to fall.***

The market price of ourcommon stock could decline as a result of sales by our existing stockholders ofshares of common stock in the market, or the perception that these sales couldoccur. These sales might also make it more difficult for us to sell equitysecurities at a time and price that we deem appropriate. As of May 9,2006, we have approximately 28,781,857 shares of common stock outstanding and730,000 shares of convertible preferred stock outstanding that are convertibleinto approximately 5.3 million shares of our common stock, plus up to a maximumof approximately 1.1 million additional shares of our common stock issuable atour option in satisfaction of the maximum dividend make-whole payment on theseshares of preferred stock. All of the shares of common stock issuable uponconversion of our preferred stock will be freely tradable without restrictionunder the federal securities laws unless purchased by our affiliates.

***The terms of our outstanding shares of preferred stock mayrestrict our ability to raise additional capital or hamper or prevent anacquisition of us.***

In February 2005, weissued and sold 900,000 shares of our 6.5% convertible exchangeable preferredstock. As of May 9, 2006, 730,000 of these shares of preferred stock areoutstanding. In the event of our voluntary or involuntary dissolution,liquidation or winding up of Acusphere, holders of our preferred stock willreceive a liquidation preference in an amount equal to $50 per share, plus allaccrued and unpaid dividends through the distribution date. Only after holdersof the preferred stock have received their liquidation preference and anyaccrued and unpaid dividends will we distribute assets, if any are remaining,to our common stock holders. Without the vote or consent of the holders of atleast a majority of the shares of preferred stock, we can not authorize or sellany equity security that ranks senior to the preferred stock as to dividends ordistributions of assets upon liquidation, dissolution or winding up of Acusphere.As a result of this liquidation preference, it may be difficult for us to raiseadditional capital through the sale of common stock or junior preferred stockon acceptable terms, or at all.

In addition, without thevote or consent of the holders of at least a majority of the shares ofpreferred stock we may not effect a consolidation or merger with another entityunless the preferred stock that remains outstanding and its rights, privilegesand preferences are unaffected or are converted into or exchanged for preferredstock of the surviving entity having rights, preferences and limitationssubstantially similar, but no less favorable, to the convertible preferredstock. This provision could hamper a third party’s acquisition of us ordiscourage a third party from attempting to acquire control of us via a merger.

***Under some circumstances, the holders of our outstandingshares of preferred stock may be entitled to elect some of the directors ofAcusphere.***

In February 2005 weissued and sold 900,000 shares of our 6.5% convertible exchangeable preferredstock. As of May 9, 2006, 730,000 of these shares of preferred stock areoutstanding. Cumulative dividends accrue on our preferred stock at an annualrate of $3.25 per share, payable quarterly on the first day of March, June, September andDecember, commencing June 1, 2005. Any dividends must be declared by ourboard of directors and must come from funds that are legally available fordividend payments. If we have not paid dividends on the preferred stock in anaggregate amount equal to at least six quarterly dividends whether or notconsecutive, we must increase the size of our board of directors by twoadditional directors. After this time, and for so long as these dividendsremain due and unpaid, holders of the preferred stock, voting separately as aclass with holders of preferred stock ranking on the same basis as to dividendshaving like voting rights, will be entitled to elect two additional directorsat any meeting of stockholders at which directors are to be elected. Thesedirectors will be appointed to classes on the board as determined by our boardof directors. These voting rights will terminate when we have declared andeither paid or set aside for payment all accrued and unpaid dividends. The termsof office of all directors so elected will terminate immediately upon thetermination of these voting rights.

***Provisions of Delaware law or our charter documents coulddelay or prevent an acquisition of us, even if the acquisition would bebeneficial to our stockholders, and could make it more difficult for you tochange management.***

Provisions of Delawarelaw or our charter or by-laws could hamper a third party’s acquisition of us,or discourage a third party from 

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attempting to acquirecontrol of us. Stockholders who wish to participate in these transactions maynot have the opportunity to do so. These provisions could also limit the pricethat investors might be willing to pay in the future for shares of our commonstock. Further, these provisions make it more difficult for stockholders tochange the composition of our board of directors in any one year.

These provisions include:

·      aprovision allowing us to issue preferred stock with rights senior to those ofthe common stock without any further vote or action by the holders of thecommon stock;

·      theexistence of a staggered board of directors in which there are three classes ofdirectors serving staggered three-year terms, thus expanding the time requiredto change the composition of a majority of directors and potentiallydiscouraging someone from making an acquisition proposal for us;

·      theby-laws’ requirement that stockholders provide advance notice when nominatingour directors;

·      theinability of stockholders to convene a stockholders’ meeting without thechairperson of the board, the chief executive officer, the president or amajority of the board of directors first calling the meeting; and

·      theapplication of Delaware law prohibiting us from entering into a businesscombination with the beneficial owner of 15% or more of our outstanding votingstock for a period of three years after the 15% or greater owner first reachedthat level of stock ownership, unless we meet specified criteria.

***We have never paid dividends on our common stock, and we donot anticipate paying any cash dividends on our common stock in the foreseeablefuture.***

We have paid no cashdividends on our common stock to date and, other than cash dividends paid onour preferred stock, we currently intend to retain our future earnings, if any,to fund the development and growth of our businesses. In addition, the terms ofany future debt or credit facility may preclude us from paying these dividends.As a result, capital appreciation, if any, of our common stock will be yoursole source of gain for the foreseeable future.

**ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None

**ITEM 3. DEFAULTSUPON SENIOR SECURITIES**

None

**ITEM 4. SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

None

**ITEM 5. OTHERINFORMATION**

None

**ITEM 6. EXHIBITS**
| Exhibit  Number | ** ** | **Exhibit Description**                            |
|-----------------|------------|---------------------------------------------------------|
| 31.1            |       | Rule 13a-14(a) / 15d-14(a) Certification |
|            |       |                                                    |
| 31.2            |       | Rule 13a-14(a) / 15d-14(a) Certification |
|            |       |                                                    |
| 32.1            |       | Section 1350 Certifications                        |

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized on this 12th day of May 2006.

 
|          |     | ACUSPHERE, INC. |
|----------|----------|-----------------|
|     |     |            |   |   |
|     |     | By:             |   | /s/ SHERRI C. OBERG |
|     |     |            |   | Sherri C. Oberg |
|     | * * | * *        | * * | *President and Chief Executive Officer* |
|     |     |            |   |   |
|     |     | By:             |   | /s/ JOHN F. THERO |
|     |     |            |   | John F. Thero |
| * * | * * | * *        | * * | *Senior Vice President and Chief Financial Officer* |
|     | * * | * *        | * * | *(Principal Financial  and Accounting Officer  and* |
|     | * * | * *        | * * | *Duly Authorized Officer)* |

 

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**EXHIBITINDEX**
| Exhibit  Number | ** ** | **Exhibit Description**                            |
|-----------------|------------|---------------------------------------------------------|
| 31.1            |       | Rule 13a-14(a) / 15d-14(a) Certification |
|            |       |                                                    |
| 31.2            |       | Rule 13a-14(a) / 15d-14(a) Certification |
|            |       |                                                    |
| 32.1            |       | Section 1350 Certifications                        |

 

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